tag:theconversation.com,2011:/africa/topics/2007-08-financial-crisis-12885/articles2007/08 financial crisis – The Conversation2019-02-17T19:43:03Ztag:theconversation.com,2011:article/1116822019-02-17T19:43:03Z2019-02-17T19:43:03ZThe exorbitant cost of climate procrastination<p>From COP24’s disappointing final agreement to France’s <a href="https://www.theguardian.com/world/2018/dec/05/france-wealth-tax-changes-gilets-jaunes-protests-president-macron">abandonment of the carbon tax increase</a> due to the “gilets jaunes” movement… it seems that concerns about climate change have fell to the very bottom of the global political agendas. </p>
<p>The current pace of CO<sub>2</sub> emissions and national commitments outlined in the wake of the Paris Agreement still put the world on track toward 3°C of warming above preindustrial temperatures by the end of this century. This lies far beyond the +1.5°C target considered as the most acceptable for all participant countries during the 21st Conference of the Parties which took place in Paris in 2015. Even the +2°C target, although less binding, still remains out of reach under current trends and policies.</p>
<p>A 3°C warming would wreak havoc on the planet, justifying the absolute necessity of the +1.5°C limit. However, even a +1.5°C change would incur heavy consequences. The adaptation cost would undoubtedly be high both for current and future generations: loss of agricultural yields, sea-level rise, whole regions rendered uninhabitable, leading to massive flows of climate migrants, collapse of the ecosystems and impoverished biodiversity, extreme meteorological events, seashore and topsoil erosion… All these effects will grow even more dire as global warming proceeds.</p>
<p>It would thus be irresponsible to downplay the climate issue by considering it less urgent than social or economic crises.</p>
<h2>When will the carbon budget be depleted?</h2>
<p>How to put back climate urgency at the core of discussions and commitments? One potential answer would be to give a monetary value to the procrastination that delays the decarbonisation of the economy.</p>
<p>In order to do so, we rely on what climatologists call the “global carbon budget”. This is the quantity of greenhouse gases (GHG) that can be emitted while keeping global warming under a given threshold (for example, +2°C or +1.5°C for the Paris agreement). The computation of this carbon budget includes carbon sinks (such as the oceans and the biomass) as well as GHG other than CO<sub>2</sub>.</p>
<p>Failing to commit to decarbonisation immediately will lead to an early exhaustion of the carbon budget.</p>
<p>Using projected emissions pathways, it is possible to compute the year by which the carbon budget will be depleted. Should this happen, we will be compelled to cut our emissions immediately and entirely. But this way of complying with the environmental constraint is utterly absurd since it exacerbates the procrastination logic.</p>
<p>Less costly ways to achieve decarbonisation exist. But extreme procrastination provides an upper bound for the decarbonisation cost. Given an estimate of the depletion year, the decarbonisation cost can be calculated by discounting the cost of emissions reduction using a backstop technology able to capture and store CO<sub>2</sub> (see for instance <a href="http://www.climeworks.com/">Climeworks</a>). The total cost grows over time, year after year, as long as we do not pay for it. It is therefore comparable to a debt, which is why we refer to it as a “climate debt”.</p>
<h2>10 years left</h2>
<p>We find striking results, as shown in the following table. The EU carbon budget will be depleted within 10 years for the +2°C target, while the corresponding EU climate debt is larger than 50% of the GDP.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/258520/original/file-20190212-174867-vp69xs.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/258520/original/file-20190212-174867-vp69xs.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=219&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/258520/original/file-20190212-174867-vp69xs.png?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=219&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/258520/original/file-20190212-174867-vp69xs.png?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=219&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/258520/original/file-20190212-174867-vp69xs.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=275&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/258520/original/file-20190212-174867-vp69xs.png?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=275&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/258520/original/file-20190212-174867-vp69xs.png?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=275&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="https://www.ofce.sciences-po.fr/pdf/pbrief/2018/OFCEpbrief45.pdf">iASES 2019, chapter 3</a>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>This estimation is speculative by nature – it is based on future emissions projections and cost estimates for future emissions reduction technologies. Using a stricter set of hypotheses can lead to a 200% of GDP climate debt for the European Union. (The <a href="https://www.ofce.sciences-po.fr/pdf/pbrief/2018/OFCEpbrief45.pdf">OFCE’s policy brief</a> details more precisely the parameters and assumptions made.)</p>
<p>For the even harsher +1.5°C constraint, the EU carbon budget is already depleted. The European Union shows an “excessive climate deficit” and implicitly borrows from other countries – as long as the global carbon budget is not depleted – and then from the climate – when the global carbon budget will be entirely depleted. For this target, the European climate debt is about 120% of GDP.</p>
<p>This climate debt is huge, in particular for the +1.5°C target. Worse, it grows whenever we postpone the implementation of environmental policies. This increase is linked to the growing gap between decarbonisation pathways and the effective emissions trend on the one hand and to the cost of borrowing from other countries and the climate on the other.</p>
<h2>Action now is less costly than the 2008 financial crisis</h2>
<p>When the global budget is depleted, further procrastination will entail overshooting the +1.5°C or +2°C threshold. Bringing global warming back on target will then require negative emissions, which will be costlier than not overshooting.</p>
<p>The magnitude of our estimates also illustrates our responsibility. The +2°C target cost can be put on a par with an investment flow of 1% (and up to 4% when considering the strictest hypotheses) of the European GDP each year until the end of the century. This is comparable in magnitude to the results reported in the 2006 <a href="https://webarchive.nationalarchives.gov.uk/+tf_/http:/www.hm-treasury.gov.uk/sternreview_index.htm">Stern report</a> – the first major study to provide economic estimates of the impacts of climate change – while using a different methodology. It is also quite close to the 180 billion euros of green investments estimated by the European Commission in its assessment of green investment needs for the EU.</p>
<p>1% of GDP to stick to the +2°C target implies less consumption, less productive investments or even less education, since this “investment” does not grant any other advantage than reducing CO<sub>2</sub> emissions. It is also a challenge for inequalities since some of climate change mitigation policies instruments used have significant distributional impacts, and may impact lower income households disproportionately.</p>
<p>But it remains small enough to not have any excuses for giving up the commitment of the COP21: the 2008 crisis represents a bigger loss of GDP than that. The +1.5°C target is of course more restrictive; the investment flow is about 2.4% of GDP, and can go well beyond depending on the chosen scenarios.</p>
<h2>The issue of burden sharing</h2>
<p>This estimation also highlights the sensitivity of climate debt to the sharing rules – namely how the carbon budget is to be split between the countries of the globe. For example, depending on whether we share the carbon budget based on a snapshot of Europe’s share of global emissions taken in 2018 or 1990, the climate debt varies from a ratio of 4 to 1.</p>
<p>The first method (using 2018 as a reference point) benefits developed countries, which have been emitting more per capita than the rest of the world since 1990. Adopting a producer approach by ignoring imported carbon in goods manufactured elsewhere (net of exportations) also reduces the responsibility of developed countries.</p>
<p>The choice of burden sharing methodology also influences estimations within Europe. COP21 innovated by setting aside the issue of shared responsibility and allowing every country to express its own. But the world is (still) closed and what some do not do will be to the detriment of all.</p>
<p>Our quantification indicates that implicit transfers between states, including within the EU, go into the double-digits points of GDP. Not only does postponing the debate about how we should share the burden increase the burden but it also generates future conflicts, especially as climate change becomes more urgent.</p>
<p>The following quote is attributed to the British physicist Lord Kelvin, <a href="http://www.manoa.hawaii.edu/ctahr/aheed/Carl/supplementary%20readings/McCloskey_1983_The_rhetoric_of_economics.pdf">pillar of the classical scientific approach</a>, reproduced on the pediment of the building of Social Sciences of the University of Chicago:</p>
<blockquote>
<p>“When you can measure what you are speaking about, and express it in numbers, you know something about it, when you cannot express it in numbers, your knowledge is of a meagre and unsatisfactory kind.”</p>
</blockquote>
<p>To that <a href="http://www.manoa.hawaii.edu/ctahr/aheed/Carl/supplementary%20readings/McCloskey_1983_The_rhetoric_of_economics.pdf">Frank Knight</a> or <a href="https://onlinelibrary.wiley.com/doi/abs/10.1002/1520-6696%28198410%2920%3A4%3C319%3A%3AAID-JHBS2300200402%3E3.0.CO%3B2-3">Jacob Viner</a>, both professors of economics at the same university, would have answered:</p>
<blockquote>
<p>“Yes, and when you can express it in numbers your knowledge is of a meagre and unsatisfactory kind.”</p>
</blockquote>
<p>Estimating the climate debt faces the same pitfalls – the risk of disaster could be trivialized, while discouraging goodwill. But if we are to reduce it, we first have to measure it.</p><img src="https://counter.theconversation.com/content/111682/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The climate issue cannot be considered less urgent than the social or economic crisis.Xavier Timbeau, Économiste à l'Observatoire français des conjonctures économiques (OFCE), Sciences Po – USPCAdeline Gueret, Économiste à l’Observatoire français des conjonctures économiques (OFCE), Sciences Po – USPCAurélien Saussay, Économiste à l’Observatoire français des conjonctures économiques (OFCE), Sciences Po – USPCPaul Malliet, Économiste à l’Observatoire français des conjonctures économiques (OFCE), Sciences Po – USPCLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1074862018-11-25T19:36:06Z2018-11-25T19:36:06ZMobilising the social sciences to rethink finance<figure><img src="https://images.theconversation.com/files/246931/original/file-20181122-182056-1qi9riv.jpg?ixlib=rb-1.1.0&amp;rect=0%2C38%2C1497%2C965&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">The authors of the book _The Making of Finance_ highlight the intellectual capture of the financial worlds.</span> <span class="attribution"><span class="source">Bart Sadowski/Shutterstock</span></span></figcaption></figure><p>Ten years have passed since the collapse of Lehman Brothers: this unprecedented event remains today a topic of the greatest concern. Indeed, <a href="https://www.versobooks.com/books/653-a-theory-of-capitalist-regulation">regulation theory</a> teaches us that the major financial crises – those of 1929 and 1987, for example – prompt structural transformations with regard to economic and financial regulation. Yet since 2008 (almost) nothing has changed in the financial world, despite the implementation of a number of new regulations on either side of the Atlantic.</p>
<h2>Intellectual stranglehold</h2>
<p>These past years, researchers have highlighted the problems faced by the public regulator in implementing the necessary structural reforms. For our part, we would like to stress another dimension, too often shrouded in silence: the formidable intellectual stranglehold to which the financial world is subjected. Since the beginning of the 1970s, orthodox financial theory has established itself as a dogma, capturing the imagination of the financial world, imposing its principles, and in this way providing legitimacy to a single model for the organisation – and thus the regulation – of the finance industry. Yet, at the beginning of the twenty-first century, the industry has become more than ever a common good, and all those involved need to act for the good of society.</p>
<p>For this reason, finance should be studied by all the social sciences. This cross-disciplinary approach is the only one that makes it possible to understand the powerful complexity of its social, political, and ideological dimensions. What needs to be promoted, ten years after the financial crisis, is how the social sciences can be used collectively to develop a new conception of finance. What follows is based on the book we have just published, <a href="https://www.routledge.com/The-Making-of-Finance-Perspectives-from-the-Social-Sciences/Chambost-Lenglet-Tadjeddine/p/book/9781138498570"><em>The Making of Finance: Perspectives from the Social Sciences</em></a>. We present the wealth of social studies of finance and reveal the fabric of the financial system, with the aim of contributing to the democratisation of knowledge in this field.</p>
<h2>A naturalistic vision based on standard financial theory</h2>
<p>The dominant paradigm of orthodox financial economics mobilises in particular the <a href="https://www.investopedia.com/terms/m/modernportfoliotheory.asp">portfolio theory</a> and the <a href="https://www.investopedia.com/terms/e/efficientmarkethypothesis.asp">efficient market hypothesis</a> to study banking and financial activity. In this paradigm, financial assets, whether shares, or bonds issued by a firm or a sovereign state, have just two mathematical dimensions: expected yield, and risk, measured by variance. Nor should we forget the price normality (or log-normality) hypothesis, which is at the heart of this orthodox vision, and which serves both to build up an optimal portfolio (<a href="https://www.investopedia.com/terms/c/capm.asp">CAPM model</a>) and to calculate risk cover (<a href="https://www.investopedia.com/terms/b/blackscholes.asp">Black-Scholes formula</a>).</p>
<p>Optimal capital allocation becomes possible in such a naturalistic, objectivised world: financial economics sees society as a collection of vectors possessing statistical properties. This theoretical frame, which could have remained an ideal frame, has today become the foundation for the legitimacy of standard finance; it justifies the role of finance in transferring wealth over time and in the management of related risk. This orthodox vision is also the origin of finance’s claim to recognise rights over future wealth. This same theoretical frame justifies the gradual financialisation of the economy, which has been advancing inexorably since the end of the 1970s. Above all, it has served (and continues to serve) as the basis on which the regulators develop the norms that constrain financial activity.</p>
<p>Yet the financial world is more than these abstract representations, because it is above all made up of social spaces. This is where <a href="http://ssfa.free.fr/index.php?&amp;lang=en">social studies of finance researchers</a>, unfortunately over discreet in the public debate on Finance, can be of help. They know that the financial world, like every organisational ensemble, is the result of history, of political compromises, of social relationships and of power balances, which have all contributed to the establishment of rules, mechanisms, and shared institutions. With all due respect to the dominant naturalistic vision, the financial markets are anything but “objective” or “natural.”</p>
<h2>Finance: a legitimate field of study for the social sciences</h2>
<p>So what exactly do the social sciences have to offer? Are they really capable of understanding what is at issue within financial intermediaries, market structures, and regulatory bodies? The promise offered by the social sciences, in their inherent diversity, lies above all in the denaturalising approach to finance. Investigating the eminently material, social, and political nature of the financial markets makes it possible to reopen the public debate about financialisation policies and regulatory orientations. Thus, through the social sciences we can envisage the foundations of a challenge to the supremacy of finance.</p>
<p>Since the end of the 1980s, many social studies of finance have based their analyses on empirical methods, undertaken by unorthodox economists, sociologists, anthropologists, management scholars, and historians. Using a range of techniques for data collection, source criticism, and comparative analysis, the authors following this research trend share the desire to understand financial activity better by freeing themselves from common assumptions about it. The proximity of these researchers to their topics, resulting from different investigatory techniques (including above all ethnography), makes it possible to develop fine-grained, in-depth analyses, accurately situated both temporally and geographically.</p>
<p>The <a href="https://www.taylorfrancis.com/books/e/9781351016100/chapters/10.4324%2F9781351016117-1">collective work</a> that we have just published presents 30 representative contributions from this work, and attempts to show how the financial industry establishes its legitimacy, particularly in terms of theory. We also explain that the development of its activity is based on an increasingly wide-stretched division of work, which also puts the financial industry in a position of force to impose its own forms of regulation.</p>
<p>Unlike traditional financial economics, which operates based on modelling and empirical generalisation, the social sciences base their legitimacy on a constant movement back-and-forth between theoretical abstraction and observation of actual practice. The <a href="https://www.centre-max-weber.fr/Bernard-Lahire">French sociologist Bernard Lahire</a> in particular has emphasised in his work the dual implications of the empirical foundations of social theories. By constantly situating research within a historical, spatial, or cultural frame, they give the notion of context all its relevance – particularly, according to Lahire, when we add the scale of observation chosen by the researcher. By promoting the idea that different scales are necessary to understand a single social fact, the different perspectives and theoretical approaches specific to each of these disciplines fade away, leaving in their place a continuum of complementary interpretations.</p>
<p>Thus, by contrasting ideas and fields through the lens of the different perspectives of the multiple disciplinary fields that comprise the social sciences, it is jointly possible to develop detailed representations of the phenomena under study. <em>The Making of Finance</em> is rooted in this desire for an interdisciplinary approach combining a variety of theoretical frameworks: economic sociology, convention theory, the philosophy of norms, economic anthropology, neo-institutional sociology, sociology of work, geography of finance, sociology of law, pragmatic sociology, institutional economics, and the regulation school. This diversity makes multiple dialogue possible, and can give birth to open debate of a shared topic: the financial world.</p>
<h2>The fabric of finance</h2>
<p>Three objectives underlie the work presented in the Making of Finance: to deconstruct standard financial theory, to study the dynamics of how the financial industry is organised, and finally to bring to light a new regime for capital accumulation – financialisation. We make our observations at three levels traditionally used in economic sociology: techniques, organisations, and institutions. By providing the reader with an analytical frame that combines these three critical orientations with three levels of observation, we make possible multiple complementary analyses of finance. The same reality – for example, financial law, banking institutions, or the notion of risk – observed by researchers from a broad range of disciplines using different theoretical approaches, will be interpreted in different ways. When the anthropologist uses the notion of the imaginary to give meaning to the different representations employed by managers, the unorthodox economist will call on mechanisms solving information asymmetry, and the sociologist will take a more political perspective.</p>
<p>Our analysis gives new meaning to the phenomena under observation, explains the relative strengths of the different interests at stake, and the consequences of the choices made more or less consciously by the different players gravitating around the world of finance. We therefore provide the basis for a future debate to develop new foundations and new regulations.</p>
<p>As an illustration of this, we indicate some of the many examples studied by the book’s co-authors:</p>
<ul>
<li><p>The historian of financial thinking, <a href="https://www.taylorfrancis.com/books/e/9781351016100/chapters/10.4324%2F9781351016117-11">Franck Jovanovic</a>, discusses orthodox financial theory as a fiction rather than a “real” description of how the financial markets operate. With this in mind, he observes the discourse used in the American courts and highlights the way legal institutions have long been using orthodox financial theory to make their rulings and even design legislation, strengthening in this way the power of this representation.</p></li>
<li><p>In organization theory, <a href="https://www.taylorfrancis.com/books/e/9781351016100/chapters/10.4324%2F9781351016117-27">Benjamin Taupin</a> studies the institutional work carried out by the ratings agencies to justify themselves. This work enables them to maintain their legitimacy in spite of the criticism they have endured, and at the same time reveals the balance of institutional power at stake.</p></li>
<li><p><a href="https://www.taylorfrancis.com/books/e/9781351016100/chapters/10.4324%2F9781351016117-29">Isabelle Chambost</a> analyses the balance of power and domination at play in the financial arrangements that enable company buyouts by private equity funds. She shows how, by putting acquired targets under pressure, the different financial professions structure their different positions to generate value and transfer risk.</p></li>
<li><p>Finally, and as proposed by <a href="https://www.taylorfrancis.com/books/e/9781351016100/chapters/10.4324%2F9781351016117-32">Benjamin Lemoine</a>, it is possible to use political sociology to shed light on how the financialisation of sovereign debt transforms the ability of different social groups to act and react, by strengthening or weakening their existence. This helps us understand the political choices made by States and their democratic consequences.</p></li>
</ul>
<p>If we are to hope to find a solution to the instability of the financial system, of which the events of 2007-2008 provide just one illustration among the almost biennial crises that have occurred over the last four decades, it is important to present finance as a social and political space. Reducing the financial space to a series of naturalised prices denies all the economic and social violence that finance manages to engender: the rise of associated inequalities and subsequent populism are two clear manifestations of this today. Researchers in the social sciences must therefore more than ever participate in the unveiling and deconstructing of such mechanisms.</p><img src="https://counter.theconversation.com/content/107486/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Les auteurs ne travaillent pas, ne conseillent pas, ne possèdent pas de parts, ne reçoivent pas de fonds d&#39;une organisation qui pourrait tirer profit de cet article, et n&#39;ont déclaré aucune autre affiliation que leur poste universitaire.</span></em></p>Nothing has changed since the 2008 financial crisis. Orthodox theory continues to structure the entire financial industry, yet there is an urgent need to study the social and political nature of markets.Isabelle Chambost, Maître de conférences, Conservatoire national des arts et métiers (CNAM)Marc Lenglet, Associate Professor, Neoma Business SchoolYamina Tadjeddine, Professor, Université de LorraineLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/938072018-09-14T12:18:16Z2018-09-14T12:18:16ZSecuritisation – the complex financial product that fuelled the financial crisis is making a comeback<figure><img src="https://images.theconversation.com/files/236428/original/file-20180914-177953-1y758gj.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/abstract-contemporary-office-building-financial-district-38114689?src=A3YqwINPx-8R4sJjdCm0FQ-1-16">Nagib / Shutterstock</a></span></figcaption></figure><p>Securitisation was once lauded as an innovation designed to enhance the resilience and stability of the financial system by redistributing risk efficiently. Yet the housing bubble that burst and triggered the 2007-08 global financial crisis was fuelled by this financial mechanism.</p>
<p>It allows banks to repackage and sell bad debt, including loans and mortgages, to third party investors in the form of a security. At the micro-level, it drove opportunistic behaviour by banks, which created complex, opaque and lower quality financial assets. Ten years later and we could be seeing the return of this risky business.</p>
<p>The 2007-08 financial crisis illuminated the dark side of securitisation. When the housing bubble burst, investors suffered significant losses and lost confidence and interest in securitisation. Moreover, stringent regulatory responses to address the shortcomings in securitisation markets have rendered these transactions costly for banks to engineer. Minimal investor interest coupled with tougher regulatory requirements has had a detrimental impact on securitisation. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/216725/original/file-20180428-135803-173mfld.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img alt="" src="https://images.theconversation.com/files/216725/original/file-20180428-135803-173mfld.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/216725/original/file-20180428-135803-173mfld.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=243&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/216725/original/file-20180428-135803-173mfld.png?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=243&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/216725/original/file-20180428-135803-173mfld.png?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=243&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/216725/original/file-20180428-135803-173mfld.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=305&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/216725/original/file-20180428-135803-173mfld.png?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=305&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/216725/original/file-20180428-135803-173mfld.png?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=305&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">All issues in the US and European market (billion US$)</span>
<span class="attribution"><span class="source">Alper Kara and Solomon Y Deku. Data source: SIFMA, www.sifma.org</span></span>
</figcaption>
</figure>
<p>The volume of securities that were issued shrank substantially in the post-crisis period, especially in Europe. But, today, ten years after the crisis, European policymakers are eager to revive it. They <a href="http://europa.eu/rapid/press-release_IP-17-1480_en.htm?locale=en">say</a> that a well-functioning securitisation market will provide significant benefits to European growth. However, there is little empirical evidence supporting this claim.</p>
<h2>The dark side of securitisation</h2>
<p>Securitisation modified the traditional banking business model, where banks keep loans until maturity. It is a complex financial mechanism that enables banks to sell otherwise illiquid loans to third parties. The proceeds of the sale are then used to finance additional lending and this cycle may be followed repetitively. </p>
<p>Since the financial crisis, a large body of work has investigated the negative effects of securitisation. There is overwhelming evidence that securitisation increases the <a href="https://onlinelibrary.wiley.com/doi/abs/10.1111/jmcb.12064">credit risk of banks</a>. </p>
<p>A number of studies have found that it increases the opportunistic behaviour of banks, too. In the pre-crisis period, banks active in securitisation <a href="https://academic.oup.com/qje/article-abstract/124/4/1449/1917185?redirectedFrom=fulltext">rejected fewer loan applications</a> and <a href="https://academic.oup.com/qje/article-abstract/125/1/307/1880343?redirectedFrom=fulltext">brokered poor quality mortgages</a>. Riskier mortgages were <a href="https://www.sciencedirect.com/science/article/pii/S0304405X1200075X">more likely to be securitised</a> and some banks even <a href="https://academic.oup.com/rfs/article/29/2/384/1903200">misreported the credit quality</a> of the underlying mortgages by obscuring information from investors. </p>
<p>Banks also <a href="https://academic.oup.com/rof/article-abstract/18/3/1139/1571204?redirectedFrom=PDF">reduced their monitoring efforts</a> of the borrowers of securitised loans. Securitisations from larger banks were <a href="https://academic.oup.com/rfs/article-abstract/29/2/457/1902968?redirectedFrom=fulltext">granted rating favours by credit rating agencies</a>, thereby misleading investors. Unable to assess the risk due to the complex structure of these assets and a lack of information, investors were impelled to rely on credit ratings. </p>
<h2>Europe immune?</h2>
<p>These undesired consequences of securitisation on bank behaviour were much less evident in the European market. European banks did not seem to have securitised <a href="https://www.sciencedirect.com/science/article/pii/S1572308916300572">low quality loans</a> or <a href="https://www.sciencedirect.com/science/article/pii/S0304393214001597">relaxed lending standards</a> in the same way that US banks did. </p>
<p>In fact, the securities market in Europe was more robust. In the post crisis period, average defaults ranged between <a href="https://www.ecb.europa.eu/press/key/date/2014/html/sp140407.en.html">0.6 and 1.5%, compared with 9.3 to 18.4%</a> for US securitisations. Nevertheless, the securitisation volume in European markets has suffered equally, if not more than, the US market. </p>
<p>The growing amount of European securitisations is, on the one hand, deceptive as not all the securities created are actually sold onto private investors. A large amount is retained by the issuing banks and subsequently used as collateral to secure funding from central banks such as the European Central Bank. But, on the other hand, UK banks have recently increased their issuance levels significantly relative to pre-Brexit levels. </p>
<h2>Lessons learned</h2>
<p>Since the crisis, European regulation has tightened significantly. In particular, it has targeted the negative effects of securitisation on bank behaviour and increased transparency in the markets. Banks must hold more capital for asset-backed securities, they must take more responsibility for their own risk and investors are now <a href="https://www2.deloitte.com/uk/en/pages/financial-services/articles/securitisation-investor-due-diligence.html">required to perform due diligence</a>.</p>
<p>But, given the current market stagnation, the securitisation framework has been revised repeatedly to revive the market. After much debate, Europe’s <a href="http://www.europarl.europa.eu/RegData/etudes/BRIE/2017/608777/EPRS_BRI(2017)608777_EN.pdf">new securitisation regulatory framework</a> will come into effect fully on January 1 2019. </p>
<p>In particular, the new framework aims to promote the issuance of simple, transparent and standardised securitisations that are easy to evaluate and monitor by investors and regulators alike. For example, to be eligible, underlying assets should be “homogeneous” by type (having similar cash flow characteristics and risk) as well as maturity. The framework provides capital relief for investors who wish to hold these simple, transparent and standardised securitisations. </p>
<p>But there are still some shortcomings. The capital relief advantages are not applicable to large long-term institutional investors such as pension funds and insurance companies. Countries will also be given the autonomy to impose sanctions on non-compliance with the risk responsibility measures. This may potentially temper cross-border activity. </p>
<p>Despite these limitations, the new framework is expected to broaden investment opportunities for long-term investors. The EU hopes it will <a href="http://europa.eu/rapid/press-release_IP-17-1480_en.htm?locale=en">boost lending to European households and businesses</a> by providing an extra €150 billion to the real economy. But, with a lack of evidence to support this and with the dark side of securitisation in mind, it’s important to tread carefully and learn from the lessons of the financial crisis.</p><img src="https://counter.theconversation.com/content/93807/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The housing bubble that burst and triggered the 2007-08 global financial crisis was fuelled by securitisation.Alper Kara, Professor of Finance, University of HuddersfieldSolomon Y Deku, Lecturer in Finance, Nottingham Trent UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1019172018-09-13T06:55:52Z2018-09-13T06:55:52ZStock market crashes linked to higher rates of suicide – new research<figure><img src="https://images.theconversation.com/files/236022/original/file-20180912-133886-86fpdo.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/failure-stock-investment-611300075?src=Qe8AsAFlsPAGIVwh65bIsA-1-37">taa22/shutterstock.com</a></span></figcaption></figure><p>Writing in the wake of the 1929 stock market crash, New York Times columnist Will Rodgers commented that the level of panic was such that it induced <a href="https://www.nytimes.com/1929/10/25/archives/will-rogers-says-new-york-has-had-a-wailing-day.html">a spate of suicide among traders</a>. Although stories of increased rates of suicide in the aftermath of a financial meltdown are deeply ingrained in the folklore of finance, until now these have not been investigated empirically. </p>
<p>Our <a href="https://ssrn.com/abstract=3213334">new international study</a> for the first time looks at the relationship between stock market fluctuations and the rate of suicides among the general population. The financial fortunes of many of us are tied in some way to the markets either directly through our investments or indirectly through our pension funds. Therefore, when markets collapse, the effects can reverberate through the whole of society. </p>
<p>Our findings suggest that suicides increase both in years of significant stock index decline and in the year that follows it. This prolonged reaction suggests that it may be possible to use stock market indicators to predict how likely it is that more people will kill themselves in the months following a crash. This introduces the possibility of rolling out successful preventative measures. </p>
<p>These conclusions are based on a sample of 36 countries spanning several decades and account for the other known socioeconomic drivers of suicide. We also found that the tendency to take one’s own life following stock market losses affects both men and women alike. </p>
<p>In our study, we performed a simulation based on our model to estimate the number of lives lost in the wake of the 2008 financial crisis. It appears that there were an additional 6,566 suicides across our sample nations in the 2008-09 period that were a direct consequence of the rapid decline of equity values. This estimate is disturbingly high, especially considering that it exceeds the sum total of the <a href="https://edition.cnn.com/2013/07/27/us/september-11-anniversary-fast-facts/">number of 9/11 victims</a> and <a href="http://icasualties.org/oef/">casualties of coalition forces in Afghanistan</a> since the invasion in 2001.</p>
<h2>Money, happiness and mental health</h2>
<p>The question over whether money can buy happiness has long perplexed researchers and the answers proffered are <a href="https://theconversation.com/can-money-buy-you-happiness-its-complicated-66307">not necessarily straightforward</a>. The literature has coalesced around the view that people living in more affluent economies experience higher levels of happiness. But it is observed that over time the contentment of the general public has not changed much despite rising GDP levels, a phenomenon referred to in economics as the <a href="https://theconversation.com/the-science-of-happiness-can-trump-gdp-as-a-guide-for-policy-57004">Easterlin paradox</a>. </p>
<p><a href="https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4180795/">British lottery winners</a>, for example, tend to report a greater sense of mental well-being, suggesting that there could be a link between affluence and emotional state. The effect of the windfall does, however, lead to an increased consumption of alcohol and engagement in other risky behaviours, which to some extent may offset any potential health benefits. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/236024/original/file-20180912-133895-17jj83g.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/236024/original/file-20180912-133895-17jj83g.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/236024/original/file-20180912-133895-17jj83g.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/236024/original/file-20180912-133895-17jj83g.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/236024/original/file-20180912-133895-17jj83g.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/236024/original/file-20180912-133895-17jj83g.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/236024/original/file-20180912-133895-17jj83g.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Does money make you happy?</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/portrait-very-happy-young-man-rain-148789697?src=PwRh6UGrGZ81Tc3c6kAHdQ-1-99">Minerva Studio / shutterstock.com</a></span>
</figcaption>
</figure>
<p>Other research has focused on the 2008 financial crisis and its impact on general health levels. Declining house prices which often fell below the value of outstanding mortgages significantly intensified <a href="https://www.sciencedirect.com/science/article/pii/S0277953615001203">psychological distress for homeowners</a>. This was reflected in a higher incidence of depression and an increased <a href="https://s3.amazonaws.com/academia.edu.documents/46488689/j.econlet.2013.09.00420160614-15070-1d5wnpp.pdf?AWSAccessKeyId=AKIAIWOWYYGZ2Y53UL3A&amp;Expires=1536751707&amp;Signature=z8kWtfxv3tKJO0g%2BVem5w4TJwVc%3D&amp;response-content-disposition=inline%3B%20filename%3DFinancial_distress_and_use_of_mental_hea.pdf">use of medications</a> to treat it. </p>
<p>One might suggest that a <a href="https://pdfs.semanticscholar.org/f292/32da1e563ef67b26cf8965326d4580448cb8.pdf">wide range of factors</a> beyond financial difficulties could be responsible for a higher suicide rate. It is well known that there is a link between suicide risk and social factors such as a lack of family stability, alcoholism or even population density. In terms of economic factors, the most pertinent determinants are unemployment, falling GDP, high inflation and the extent to which women participate in the labour force. </p>
<p>In our paper, we take all of these factors into account and isolate cleanly the influence of stock market movements. Even if market crashes typically overlap with periods of economic recession, they appear to generate an impact on voluntary deaths in their own right. </p>
<h2>The way forward</h2>
<p>Given what we now know about the effects of drastic declines in wealth and the instability that comes with a market crash, we should use this information to prevent unnecessary loss of life in the future. Market indices could even be used as a signalling device by which to direct resources to combat suicide. </p>
<p>Not only do stock returns reflect the fortunes of investments, they are also <a href="http://www.nber.org/papers/w5379">predictive of the future business cycle</a>. As such, policymakers could view markets as a harbinger of financial distress and direct more resources towards mental healthcare provision following market slumps. </p>
<p>While financial theory considers the issue of investment risk, it neglects to consider the human cost attached to market losses. Those who offer investment guidance should not be blind to the emotional risks involved and look after their client’s best interests, not solely from a financial perspective. As well as examining how risk averse investors are, they could perform basic diagnostics to identify those who carry a high risk of succumbing to mental illness and then tailor their advice accordingly.</p><img src="https://counter.theconversation.com/content/101917/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>There were 6,566 more suicides in the 2008-09 period that were a direct consequence of the rapid decline of equity values.Brendan John Lambe, Associate Professor in Finance, De Montfort UniversityTomasz Piotr Wisniewski, Professor of Finance, The Open UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1027582018-09-12T10:38:48Z2018-09-12T10:38:48ZAnniversary of Lehman's collapse reminds us – booms are often followed by busts<p>Only a decade has passed since the collapse of <a href="https://www.investopedia.com/articles/economics/09/lehman-brothers-collapse.asp">Lehman Brothers</a>, and it seems the mortgage crisis and subsequent <a href="https://theconversation.com/us/topics/great-recession-13707">Great Recession</a> are already ancient history in the minds of many investors, bankers and regulators.</p>
<p>All it took was a few short years of <a href="https://www.housingwire.com/articles/41000-spexperian-mortgage-default-rate-at-lowest-level-in-a-decade">low default rates</a> and <a href="https://www.clearbridge.com/perspectives/institutional/2018/bank-balance-sheets-loan-growth-interest-rates.html">good loan growth</a> to re-create the kind of heady atmosphere of <a href="https://www.marketwatch.com/story/this-irrational-exuberance-indicator-could-spell-trouble-for-the-stock-market-2017-06-21">irrational</a> <a href="https://www.cnbc.com/2017/10/31/spooky-market-valuations-at-greenspan-irrational-exuberance-level.html">exuberance</a> that <a href="http://blog.runnymede.com/alan-greenspan-warns-of-irrational-exuberance-in-bonds">transforms</a> staid bankers into high-wire risk takers. </p>
<p>For those who have forgotten, such risk takers are the the ones who <a href="https://www.thebalance.com/what-caused-2008-global-financial-crisis-3306176">caused</a> the 2008 crisis, which resulted in the collapse of investment bank Lehman Brothers on Sept. 15 and the worst recession since the 1930s. </p>
<p>With their hubris restored, bankers once again have convinced themselves and others that they are the “<a href="https://www.harpercollins.com/9780887309328/masters-of-the-universe/">masters of the universe</a>,” with superhero risk management skills. </p>
<p>At the same time, regulators are beginning to <a href="http://dealbook.nytimes.com/2014/10/22/u-s-loosens-reins-but-mortgage-lenders-want-more-slack/?_r=0">loosen</a> their reins, in part on the belief that the booming economy, flush with the <a href="https://www.usnews.com/news/business/articles/2018-01-03/fed-officials-hopeful-for-economic-boost-from-tax-cuts">gains</a> from tax breaks and deregulation, no longer needs such restraints.</p>
<p>But, as <a href="https://scholar.google.com/citations?user=mm2zaS8AAAAJ&amp;hl=en&amp;oi=ao">my research</a> into <a href="http://dx.doi.org/10.2139/ssrn.2587168">past financial crises</a> has shown, the seeds of the next bust tend to be sown during the boom times.</p>
<h2>Boom foreshadows doom</h2>
<p>A psychological bias known as the <a href="https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/availability-heuristic/">availability heuristic</a> helps explain why this happens. </p>
<p>This is sort of a mental shortcut in which people rely on only the most readily available information, such as from the very recent past, to arrive at inferences about the current and future state of affairs. In other words, if things are going well, it’s easy to convince yourself that they’ll continue that way indefinitely.</p>
<p>And this bias becomes very prevalent on Wall Street when times are good, leading to the kind of reckless behavior that sparks crises. </p>
<p>Research into the conditions that existed prior to the major financial crises of the past eight centuries shows that virtually every one <a href="http://www.nber.org/papers/w13761.pdf">was preceded</a> by an asset price bubble in the economy – which makes it appear like it’s booming – and an excessive amount of debt held by banks, conditions that suggest an environment tolerant of high risk. </p>
<p><a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2587168">My own research</a> into the conditions and causes of the last two major financial crises – in the 1980s and 2008 – reveals that the longer a lending boom lasts, the more trouble it foreshadows. More generally, during booms, any aspects of risk management in financial institutions <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2565499">get corrupted</a> by a kind of overconfidence in the skills of bankers. </p>
<p>And that’s exactly the environment we have now. A <a href="https://www.forbes.com/sites/bradmcmillan/2016/07/07/should-we-be-worried-about-record-low-interest-rates/">decade of ultra-low interest rates</a> across the world have led to <a href="https://www.cnbc.com/2018/07/11/global-debt-hits-a-new-record-at-247-trillion.html">ever-rising debt loads</a> for every type of borrower in most countries and have created incentives for <a href="https://voxeu.org/article/new-take-low-interest-rates-and-risk-taking">increased risk-taking</a> among investors and traders in the pursuit of high yields. </p>
<p>I believe this is putting the global financial system at risk of another collapse if regulators don’t act soon.</p>
<figure>
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<figcaption><span class="caption">The author explains how booms can turn into crises.</span></figcaption>
</figure>
<h2>Stemming the cycle</h2>
<p>So is there something we can do to break this cycle and avert another crisis? </p>
<p>In my view, it primarily comes down to capital requirements, which are rules meant to ensure banks have enough equity – and not too much debt as percentage of total assets – to absorb the risk they’re taking with their investments. </p>
<p>In short, the <a href="http://www.bis.org/bcbs/basel3.htm">current requirements</a> are just not high enough to protect banks and the financial system. Furthermore, regulators tend to loosen them and <a href="https://www.npr.org/sections/thetwo-way/2018/05/22/613390275/congress-to-undo-part-of-dodd-frank-easing-rules-for-mid-sized-smaller-banks">other lending requirements</a> when the economic picture is improving – the precise time when they should be raising them. </p>
<p>Asking banks to hold more capital in good times, like now, will put in place the right incentives to prevent the kind of behavior that puts entire economies at risk. That’s because the more capital banks have, the more circumspect they’ll be in terms of how much risk they take, thus making a bust caused by the kinds of investments they made in the run-up to the last financial crisis much less likely. </p>
<h2>Beefing up Basel III</h2>
<p>One way regulators could do this is by beefing up <a href="http://www.bis.org/bcbs/basel3.htm">Basel III</a>, a voluntary, global regulatory framework on bank capital adequacy, stress-testing and market liquidity risk. </p>
<p>Basel III set banks’ so-called leverage ratio – a measure of how much capital a lender has relative to debt – at 3 percent. U.S. regulators have gone a bit further, requiring 5 percent. But that’s <a href="http://apps.olin.wustl.edu/faculty/Thakor/Website%20Papers/PostCrisis_JFS_37(2018).pdf">far too low</a> for a healthy banking system. </p>
<p>Regulators <a href="http://dx.doi.org/10.2139/ssrn.2341835">should be aiming</a> for 15 percent because research has shown that such a ratio will reduce the systemic risk of the banking sector significantly. With that much equity capital on their balance sheets, banks will resist the temptation to take undue risks that jeopardize the safety net taxpayers provide them through deposit insurance and occasional bailouts. </p>
<p>The greater cushion will also give them more time to adjust when the next crisis comes, as it inevitably will. And the more capital a bank has, the more time it has to take protective actions before going belly-up as losses start wiping out its equity. </p>
<p>Just imagine, would a bank ever give you a reasonably priced home mortgage if you only put 5 percent down and wanted to borrow the other 95 percent? </p>
<p>Some <a href="https://www.americanbanker.com/opinion/theres-more-to-bank-regulation-than-higher-capital">bankers complain</a> this will hurt shareholders because being required to hold more equity as a share of total assets will lead to lower returns.</p>
<p>A paper <a href="https://doi.org/10.1093/rfs/hhq022">I co-authored in 2009</a>, however, found that higher bank capital levels are actually associated with greater bank values, not to mention a safer and sounder banking system. </p>
<h2>Preventing the next big one</h2>
<p>I’m not suggesting that regulators and banks do this overnight, but I think when the economy is doing well, <a href="https://money.cnn.com/2018/05/22/investing/banks-record-profits-fdic-deregulation-bill/index.html">lenders are doing well and profits are high</a>, it’s relatively easy to build up capital over a period of three to five years. </p>
<p>And it’s the most effective means of preventing a financial crisis.</p>
<p>What regulators often do instead is focus on restricting banking activities and driving up the costs of complying with regulations. Rather than creating systemic protection, this simply leads banks to move their riskier activities to areas of the industry where regulators aren’t looking. </p>
<p>Regulators can only do so much to keep these firms from taking excessive risks. What they can do is ensure banks have enough capital to absorb future shocks so that the global financial system isn’t once again brought to the brink of collapse. </p>
<p><em>This is an updated version of an <a href="https://theconversation.com/beware-of-bullish-bankers-their-bubbles-and-the-inevitable-burst-42084">article</a> published on May 27, 2015.</em></p><img src="https://counter.theconversation.com/content/102758/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Anjan V. Thakor does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It's when times are good that the seeds of the next financial crisis are sown.Anjan V. Thakor, Professor of Finance, Washington University in St LouisLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/939002018-04-19T10:50:24Z2018-04-19T10:50:24Z2008 financial crisis still seems like only yesterday for single women<figure><img src="https://images.theconversation.com/files/214856/original/file-20180414-570-i6t6p1.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">A woman walks by the New York Stock Exchange. </span> <span class="attribution"><span class="source">AP Photo/Richard Drew</span></span></figcaption></figure><p>For many Americans, the financial crisis that plunged the global economy into recession a decade ago may seem like a distant memory. </p>
<p><a href="https://www.federalreserve.gov/releases/z1/20180308/z1.pdf">Household net worth</a> – the difference between assets and debts – reached a record US$98.7 trillion in the last quarter of 2017, up from $56.2 trillion in 2008. </p>
<p>Yet net wealth, by itself, masks a lot of information that could signal troubling trends. For example, this measure doesn’t tell us which households are getting richer. It also doesn’t reveal how much borrowing is fueling these ostensibly swelling balance sheets. </p>
<p>More specifically, it doesn’t show that for households headed by women, particularly poorer ones, the financial picture is still very cloudy. That’s in part because, as my soon-to-be-published research shows, low-income single women borrowed a lot more than single men in the years leading up to the crisis. And their indebtedness relative to their income and wealth remains far more elevated than is the case for pretty much everyone else.</p>
<p>This is especially worrying because female-headed households are vulnerable to begin with – and so are at risk again if <a href="https://theconversation.com/recent-stock-market-sell-off-foreshadows-a-new-great-recession-92471">another crisis looms on the horizon</a>. </p>
<h2>Why debt matters</h2>
<p>To understand why debt is so integral to household financial health, it’s helpful to look at what happened during the 2008 financial crisis. </p>
<p>Overall household debt grew dramatically in the early 2000s, driven in large part by the <a href="https://files.stlouisfed.org/files/htdocs/publications/review/06/01/ChomPennCross.pdf">subprime mortgage</a> boom. This borrowing eventually reached levels that proved to be unsustainable and, after interest rates began rising in 2004, forced millions into <a href="http://money.cnn.com/2006/09/13/real_estate/foreclosures_spiking/index.htm?postversion=2006091508">foreclosure</a>.</p>
<p>While things have recovered, the significant gains in net worth are illusory, in part because <a href="https://www.washingtonpost.com/news/wonk/wp/2017/12/06/the-richest-1-percent-now-owns-more-of-the-countrys-wealth-than-at-any-time-in-the-past-50-years/?utm_term=.ba02d0976df1">they have gone disproportionately</a> to the richest households. Moreover, they have been financed through a lot more borrowing.</p>
<p>Total household debt reached <a href="https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2017Q4.pdf">a record $13.15 trillion</a> at the end of 2017, up about $2 trillion since the most recent trough in 2013. Nonhousing debt like credit cards and student loans made up most of the increase. </p>
<p>To understand why net worth is misleading, consider two households with identical net worth of $10,000: One has $15,000 of assets and $5,000 of debts, while the other has $10,000 of assets and no debts. </p>
<p>Whether the $5,000 turns out to be unsustainable or not depends on the household’s ability to service the debt and pay down the principal. If its income becomes insufficient, the debt will accumulate, and eventually the family will have less and less money for the necessities of life – as occurred during the financial crisis. </p>
<p>Sustainable debt can quickly become unsustainable if a household suffers what economists call a “shock,” or any unexpected change to the family’s ability to make ends meet, like losing a job or caring for a sick relative. And some households are more vulnerable, or <a href="https://economics.mit.edu/files/5998">financially fragile</a>, than others. </p>
<p>Unpredictable shocks can push such households over the edge.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=399&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=399&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=399&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=501&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=501&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/214855/original/file-20180414-540-xpgtw0.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=501&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Households that are financially fragile are more vulnerable to unpredictable shocks such as medical bills or job loss.</span>
<span class="attribution"><span class="source">kudla/Shutterstock.com</span></span>
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</figure>
<h2>The feminization of poverty</h2>
<p>Female household heads are particularly at risk to shocks because of their greater economic insecurity and may be more likely to use high-cost borrowing to make ends meet. </p>
<p>For a start, single women’s median wealth is <a href="http://www.mariko-chang.com/AFN_Women_and_Wealth_Brief_2015.pdf">one-third that of single men</a>. And single women – mothers in particular – <a href="http://poverty.ucdavis.edu/sites/main/files/file-attachments/policy_brief_stevens_poverty_transitions_1.pdf">have more frequent and longer poverty spells</a> and <a href="https://statusofwomendata.org/explore-the-data/employment-and-earnings/employment-and-earnings/">higher unemployment rates</a> than other households. They also experience <a href="https://www.americanprogress.org/issues/economy/reports/2017/04/27/431251/single-women-face-greatest-risk-economic-insecurity/">high levels of economic risk</a> from shocks such as divorce and unexpected care obligations. On top of all this, the social safety nets such as federal welfare programs that used to support female-headed households <a href="https://www.thenation.com/article/the-american-social-safety-net-does-not-exist/">have been weakened</a>. </p>
<p>Economists have also pointed to evidence of a “<a href="http://www.tandfonline.com/doi/abs/10.1080/10511482.2011.615850">feminization of high-cost credit</a>,” particularly among women of color. That’s because low-income single women’s economic vulnerability and historically limited access to traditional credit products have made them <a href="https://www.journals.uchicago.edu/doi/full/10.1086/675391">targets for predatory subprime lending</a>. In a 2006 sample of mortgage borrowers, more than <a href="http://www.tandfonline.com/doi/abs/10.1080/10511482.2011.615850">half of mortgages</a> owned by black single women were subprime, compared with 28 percent for non-Hispanic white single male borrowers. </p>
<h2>Pushed into the red</h2>
<p>My research, which will be published in the Forum for Social Economics, shows that female-headed households experienced a concerning increase in two major forms of borrowing leading up to the financial crisis: mortgage and educational debt.</p>
<p>Controlling for other household characteristics such as household size and marital status, I examined differences in the growth of average mortgage and student debt among single female- and male-headed households in three time periods: the late 1990s, the credit expansion of 2002 to 2007, and the post-crisis period of 2008 to 2013. I also compared differences between incomes below and above the median, which varied from $24,000 in 1995 to $35,000 in 2007.</p>
<p>My most significant finding is that average mortgage debt for households headed by lower-income unmarried, divorced or widowed women increased substantially during the credit expansion – rising from about $9,800 to $16,600 after adjusting for other household characteristics – while similar households led by single men showed no statistically significant change during the period. This gender gap persisted during the recovery; debt for men and women changed very little through 2013. </p>
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<p>One explanation is that lenders saw poorer single women – and <a href="http://www.tandfonline.com/doi/abs/10.1080/10511482.2011.615850">women of color in particular</a> – as a largely untapped market in their rush to originate all the high-interest loans that they could. <a href="https://consumerfed.org/pdfs/WomenPrimeTargetsStudy120606.pdf">Other research</a> has found that women were more likely than men to receive subprime mortgages. </p>
<p>In terms of student debt, I found that the average single woman borrowed an extra $2,000 or so during the lead-up to the crisis, compared with an increase of only $775 for men. This was particularly prevalent among younger single women. After the crisis, when many people went back to school because there were so few jobs, female-headed households increased their student debt by an additional $3,400 on average, while men borrowed an additional $2,800. </p>
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<p>One reason for this is likely that <a href="https://iwpr.org/publications/single-mothers-overrepresented-profit-colleges/">single mothers</a> are overrepresented at for-profit colleges, where students are <a href="https://files.consumerfinance.gov/f/201207_cfpb_Reports_Private-Student-Loans.pdf">three times more likely</a> than their peers at nonprofit universities to hold costly private loans. Another is that <a href="https://www.aauw.org/research/deeper-in-debt/">more women</a> were studying at college.</p>
<p>One important caveat to my data. My data show only averages over time, not how the fortunes of particular borrowers changed. In other words, I can only show trends, not whether individual households are in fact better or worse off than they were at different points in time.</p>
<h2>Wealth and financial fragility</h2>
<p>Of course, debt isn’t always a bad thing. Many households use debt to acquire assets to improve their financial situation down the road.</p>
<p>Homeownership is an <a href="https://www.nbcnews.com/feature/in-plain-sight/american-dream-home-whats-middle-class-without-house-n296346">important way</a> to build wealth, so it’s not altogether a bad thing that a record share of unmarried women <a href="https://www.nytimes.com/2017/09/28/realestate/most-unmarried-homeowners-are-women.html">owned their own homes in 2006</a>. Similarly, educational investments lead to long-run payoffs that far exceed tuition costs: Someone with a college degree <a href="https://www.aeaweb.org/articles?id=10.1257/jep.26.1.165">is estimated</a> to earn one and a half times as much as a high school graduate. </p>
<p>Still, there are good reasons to question whether all that pre-crisis borrowing really improved households’ financial health. In my own research, I found that lower-income women’s debt-to-wealth ratio doubled from the late 1990s to 2013. It turns out, the wealth created by the surge in female homeowners simply vanished when the housing bubble popped. </p>
<p>Today, as borrowing again crescendos, there are good reasons to worry that the next bursting of a debt-driven bubble is right around the corner. And when it happens, once again many low-income single women and their dependents will be among the worst hit.</p><img src="https://counter.theconversation.com/content/93900/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Melanie G. Long does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Single women borrowed heavily in the run-up to the financial crisis, ensuring they suffered the most in its fallout. Will history repeat itself?Melanie G. Long, PhD Candidate in Economics, Colorado State UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/924712018-03-19T10:38:10Z2018-03-19T10:38:10ZRecent stock market sell-off foreshadows a new Great Recession<figure><img src="https://images.theconversation.com/files/210667/original/file-20180315-104676-j2vnia.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">An ice sculpture titled &#39;Main Street Meltdown&#39; melts near Wall Street.</span> <span class="attribution"><span class="source">AP Photo/Frank Franklin II</span></span></figcaption></figure><p>In early February, concerns about inflation and rising interest rates sent global financial markets into a frenzy, <a href="https://www.npr.org/sections/thetwo-way/2018/02/05/583325123/stocks-extend-losses-with-dow-dropping-more-than-300-points-at-the-open">prompting the biggest single-day drop</a> ever in the Dow Jones Industrial Average. Stocks have since recovered some of their losses.</p>
<p>A similar episode occurred exactly 10 years earlier, <a href="https://blogs.cfainstitute.org/investor/2017/01/31/the-ars-debacle-the-forgotten-crisis-of-2008/">though few may remember</a>. In February 2008, the failure of an obscure market precipitated a <a href="https://blogs.cfainstitute.org/investor/2017/01/31/the-ars-debacle-the-forgotten-crisis-of-2008/">similar selling frenzy</a>. At the time, this sell-off went mostly unrecognized as a harbinger of something worse because the stock market quickly recovered. </p>
<p>Just as the world shouldn’t have been complacent in 2008, we shouldn’t rest easy today. Both events are proverbial dead canaries in a coal mine. </p>
<p>That’s because they have something else in common. Both stemmed from worries that rising borrowing costs would hurt debt-burdened consumers, the housing market and ultimately the U.S. economy.</p>
<p>Our soon-to-be-published research shows that the same problems that led to the biggest financial market meltdown since the Great Depression are alive and well today. </p>
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<h2>2008’s canary in a coal mine</h2>
<p>In the mid-2000s, the U.S. economy <a href="http://www.washingtonpost.com/wp-dyn/content/article/2007/01/31/AR2007013100422.html?referrer=email">seemed to be riding high</a>, but two key problems lurked below the surface: excessive household debt and a housing bubble.</p>
<p>Part of the first problem was that real, <a href="https://fred.stlouisfed.org/series/MEHOINUSA672N">inflation-adjusted household incomes were actually lower</a> than they had been in the late 1990s. To maintain living standards, Americans took on more debt thanks to <a href="https://fred.stlouisfed.org/series/FEDFUNDS">relatively low borrowing costs</a> and weak underwriting standards among lenders. <a href="https://www.newyorkfed.org/microeconomics/hhdc.html">Total household debt soared</a> more than 50 percent, from a little over US$8 trillion in 2004 to $12.69 trillion by 2008. </p>
<p>That brings us to the second problem. Most of that was mortgage debt. The housing bubble pushed it to the point <a href="http://www.jchs.harvard.edu/sites/jchs.harvard.edu/files/son2008.pdf">that it was unsustainable</a> as housing prices outstripped incomes, leading banks to come up with <a href="https://www.theguardian.com/business/2007/sep/30/5">ever creative ways</a> to lend people money they ultimately couldn’t pay back. </p>
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<p>At around the same time, the Federal Reserve began to lift interest rates, from 2004 to 2006, making credit more expensive. This reduced consumer spending as more of households’ falling real incomes went to repay debt, thus <a href="https://fred.stlouisfed.org/series/GDP">slowing economic growth</a> and the housing market. </p>
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<p>To <a href="http://keenomics.s3.amazonaws.com/debtdeflation_media/2007/03/SteveKeenDebtReportNovember2006.pdf">some observers</a>, it was only a matter of time before an economic recession or worse. </p>
<p>Among the first significant signs that things were seriously amiss came from the <a href="http://www.mondaq.com/unitedstates/x/60418/securitization+structured+finance/AuctionRate+Securities+Bidders+Remorse+A+Primer">auction rate securities</a> market, which was worth about $330 billion at its peak in 2008. Auction rate securities are essentially packages of mortgages, student loans and other medium- to long-term debt. Back in 2008, broker dealers held weekly <a href="https://www.investopedia.com/terms/d/dutchauction.asp">Dutch auctions</a> at which these short-term securities changed hands and interest rates were set after a bidding process. <a href="https://www.barrons.com/articles/SB121159302439419325">Credit-rating agencies gave them</a> their <a href="https://www.investopedia.com/terms/a/aaa.asp">super-safe ranking of AAA</a>. </p>
<p>Investors <a href="https://blogs.cfainstitute.org/investor/2017/01/31/the-ars-debacle-the-forgotten-crisis-of-2008/">liked them</a> because they were paid a much higher rate than other short-term securities with AAA ratings. Because they could be sold quickly to investors, borrowers could get loans more easily. </p>
<p>But on Feb. 7, 2008, the <a href="https://fas.org/sgp/crs/misc/RL34672.pdf">market began to seize up</a>. It started when the big investment banks, responsible for ensuring the market had plenty of “liquidity” by purchasing the securities if demand was weak, backed away because a growing number of households couldn’t repay their debts and this was beginning to squeeze their bottom lines. </p>
<p>This spooked investors, who sensed something was wrong. By the end of the month, there were no auctions, and billions of dollars in securities were frozen. The auction rate securities market remains closed to this day. </p>
<p>Within months of its February seizure, the broader market had moved on, as the Dow Jones Index reached the year’s peak by May. Yet the event sent ripples throughout the economy as investors continued to avoid mortgage-related assets. </p>
<p>By September 2008, when investment bank Lehman Brothers collapsed because of problems with these securities, the Great Recession was in full swing. </p>
<h2>Deja vu?</h2>
<p>Fast forward to today. </p>
<p>The economy has mostly recovered from the financial crisis, the <a href="https://data.bls.gov/timeseries/LNS14000000">unemployment rate has dropped</a> from 10 percent in 2009 to 4.1 percent in January and <a href="https://fred.stlouisfed.org/series/MEHOINUSA672N">real median household income surged</a> to a record at the end of 2016. </p>
<p>Good news, right? </p>
<p>Our new research shows that these rosy-looking stats conceal the same two related problems as 10 years ago: excessive consumer debt (relative to income) and unaffordable housing.</p>
<p>First, debt and income. After falling in the aftermath of the Great Recession, debt is once again reaching new highs. Especially worrisome, nonmortgage household debt (student loans and credit cards) has soared at a rapid pace and <a href="https://www.newyorkfed.org/microeconomics/hhdc.html">is now 41 percent above</a> its previous peak in 2008. We estimate that the resulting interest payments on nonmortage household debt have reduced living standards of the typical household by 3.1 percent since 2008. That either lowers consumption or prolongs the vicious cycle of more and more household debt. </p>
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<p>But things are even worse than this. Income data ignore <a href="http://www.pewresearch.org/fact-tank/2017/05/05/its-becoming-more-common-for-young-adults-to-live-at-home-and-for-longer-stretches/">recent demographic shifts</a>, such as more multi-generation households and college students living with their parents longer. We adjusted household income by family size because more people living together requires more money to attain the same living standards. Our data show this has lowered average living standards by 3.3 percent. This is on top of the 3.1 drop due to greater interest payments on nonmortgage debt.</p>
<p>Second, although there is no great housing bubble today, the fundamental problem is the same as 10 years ago – people with average incomes cannot afford to buy and live in an average priced home. Low interest rates helped the housing market recover, but <a href="https://www.usatoday.com/story/money/2017/07/25/u-s-home-prices-reach-record-high-6th-straight-month/507808001">also helped drive prices to record highs</a>. </p>
<p>Just like before the 2008 crisis, incomes <a href="https://www.cnbc.com/2018/03/13/economist-home-prices-are-increasing-twice-as-fast-as-income-growth.html">have not kept pace</a> with home prices. Too many people cannot afford to buy a home. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/210997/original/file-20180319-31602-1tgo5lb.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/210997/original/file-20180319-31602-1tgo5lb.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=403&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/210997/original/file-20180319-31602-1tgo5lb.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=403&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/210997/original/file-20180319-31602-1tgo5lb.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=403&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/210997/original/file-20180319-31602-1tgo5lb.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=507&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/210997/original/file-20180319-31602-1tgo5lb.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=507&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/210997/original/file-20180319-31602-1tgo5lb.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=507&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Dark days ahead?</span>
<span class="attribution"><span class="source">Sunny Boy/Shutterstock.com</span></span>
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<h2>Storm clouds brewing</h2>
<p>So what does this all mean? </p>
<p>Home prices and consumer debt are again at record highs, and the Fed has been steadily raising benchmark borrowing costs for over a year now. The central bank <a href="https://www.cnbc.com/2018/01/30/fed-will-be-forced-to-raise-rates-more-rapidly-than-expected-cnbc-fed-survey.html">is expected</a> to accelerate the process because the recent tax cut is likely to cause inflation to rise, requiring the Fed to lift interest rates to cool things down. This will hurt the housing market, pushing more homeowners underwater and making it harder for them to pay their mortgages and repay other debt.</p>
<p>At the same time, incomes have only grown modestly and, as our research shows, average American households have 6 percent to 7 percent less spending power than they did a decade ago, before the global financial system collapsed. Something will have to give. Households can take on more debt to maintain their living standards for a short while, or they can significantly reduce their spending. </p>
<p>In either case, the U.S. economy is primed for another recession. We believe it’s not a question of if. It’s a question of when.</p><img src="https://counter.theconversation.com/content/92471/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The collapse of an obscure corner of the financial market a decade ago foreshadowed the Great Recession. The stock-market swoon in February should offer a similar warning.Steven Pressman, Professor of Economics, Colorado State UniversityRobert H. Scott III, Professor of Economics & Finance, Monmouth UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/884202018-02-16T12:53:20Z2018-02-16T12:53:20ZHuge pension fund deficits are a global crisis in waiting<figure><img src="https://images.theconversation.com/files/206590/original/file-20180215-131013-1ueayot.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/euro-money-dominoes-on-top-banknotes-544784239">shutterstock.com</a></span></figcaption></figure><p>In the past decade, the banking industry has been a central focus of attention for regulators, academics and the general public. The 2007-08 financial crisis led to new regulations and institutions to keep things in check.</p>
<p>In contrast, the issues of the pension industry have tended to be swept deep under the carpet. Much the same way that people think about retirement saving – that it can wait for another day – we are now beginning to see how much of a mistake this is. </p>
<p>The pension industry is already in a deep financial crisis and could well be the trigger for another global financial and economic meltdown. This has largely been overlooked. Instead, it has been common to only discuss the pension industry in terms of the problems arising from ageing populations (which is, of course, <a href="https://theconversation.com/theres-more-to-pensions-reform-than-making-us-work-for-longer-55888">also important</a>).</p>
<p>While the <a href="http://money.cnn.com/2016/03/09/investing/stocks-bull-market-turns-seven/index.html">recovery</a> of many countries’ equity markets from the massive decline in 2007-09 may appear to look like good news for pension funds, it has not benefited the industry anywhere as near as much as you might expect. Many pension funds moved away from equity investments, increased the share of bonds in their portfolios and missed out on high returns. For example <a href="https://www.bankofengland.co.uk/-/media/boe/files/paper/2014/procyclicality-and-structural-trends-in-investment">UK pension funds</a> decreased their portfolios’ equity share from 61% in 2006 to 29% in 2017 and increased the bond share from 28% to 56% over the same period.</p>
<p>The net effect is that the pension industries in many countries are in a bad way. According to a <a href="http://www.agefi.fr/sites/agefi.fr/files/fichiers/2016/03/citi_retraite_hors_bilan_21_mars_1.pdf">Citibank report from 2016</a>, the 20 largest OECD countries alone have a US$78 trillion shortfall in funding pay-as-you-go and defined benefit public pensions’ obligations. This shortfall is far from trivial. It is equivalent to about 1.8 times the value of these countries’ collective national debt. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/206631/original/file-20180215-131013-3mw615.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/206631/original/file-20180215-131013-3mw615.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/206631/original/file-20180215-131013-3mw615.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/206631/original/file-20180215-131013-3mw615.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/206631/original/file-20180215-131013-3mw615.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/206631/original/file-20180215-131013-3mw615.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/206631/original/file-20180215-131013-3mw615.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">The funds are broken.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/breaking-bank-17164066">shutterstock.com</a></span>
</figcaption>
</figure>
<p>Private pensions are not any more sound. US private pensions, for example, have (across the board) only <a href="http://www.agefi.fr/sites/agefi.fr/files/fichiers/2016/03/citi_retraite_hors_bilan_21_mars_1.pdf">82% of the funds necessary</a> to meet their liabilities. That equates to a US$3 trillion shortfall. Given the importance of the US economy and its financial markets to the global financial structure, this should not be taken lightly. </p>
<p>The UK pension industry is in no better position. Its overall funding level was only 67.7% in March 2017, equivalent to a £736.2 billion deficit.</p>
<p>To put these figures in context, let us recall that the market capitalisation of the big banks before the financial crisis was small compared to the size of the pension fund deficits. For example, in 2007, the peak market capitalisation of the Royal Bank of Scotland and of Lloyds Banking Group were £64 billion and £33 billion respectively. Yet by the end of 2009 the British government had to inject <a href="http://www.independent.co.uk/news/uk/politics/163850bn-official-cost-of-the-bank-bailout-1833830.html">£850 billion in a rescue package</a> to save the UK bank sector from collapsing.</p>
<h2>A global problem</h2>
<p>So why is pension underfunding a global problem, rather than one faced by individual providers or countries? The simple answer is the unprecedented scale of the deficits and the number of economically important countries caught up in the problem. </p>
<p>Scratch a little deeper and there are additional, compounding problems. The pension industry is complex – it is globally interconnected and is tied into very long-term obligations. Yet tackling the problem at a global level is hard because of the significant diversity in countries’ regulatory and political regimes. </p>
<p>Plus, the industry often faces much lighter regulation than the banking and the insurance sectors, although it also suffers from moral hazard and the “too-big-to-fail” syndrome where it won’t have to pick up the pieces if things fall apart.</p>
<p>Making things worse, companies are opting to minimise their risks and are selling their pension obligations to insurance companies. Between 2014 and 2016, in the UK alone, <a href="https://www.ft.com/content/fc3fcf42-d1bb-11e6-9341-7393bb2e1b51">£68 billion worth of pension liabilities</a> were passed from companies to insurers. As this interconnectivity of the pension industry with the global insurance industry grows – the chance of a system-wide collapse increases.</p>
<p>The economic consequences of these sell-offs could be significant. When a company sells its pension obligations to an insurance company, it must pay substantial transfer fees – often exceeding 30% of the fund’s total value. This could otherwise be spent on things such as investment and research and development to improve productivity, which has already <a href="https://theconversation.com/debunking-the-uks-productivity-problem-88042">been low for years</a>.</p>
<p>It is also not obvious what effect these transfers will have on people’s retirement income, as it is not clear how much regulatory protection they will have once sold off. For instance, the transfer of Barclays’ pension obligations of its 284,000 members to its high-risk division means that the pension assets <a href="https://www.thetimes.co.uk/article/patrick-hosking-gwcp7pwx3">will not be ring-fenced after 2025</a>. Given that the insurance market already faces huge problems of its own (such as <a href="https://www.theguardian.com/environment/2016/dec/07/climate-change-threatens-ability-insurers-manage-risk">from climate change</a>), this lumps a lot of pensions together with another at-risk industry.</p>
<p>So, this whole issue needs ratcheting up the global regulatory agenda. If regulators do not step in soon and firmly, it will once again be taxpayers who have to come to the rescue.</p><img src="https://counter.theconversation.com/content/88420/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Ania Zalewska does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The 20 largest OECD countries alone have a US$78 trillion shortfall in their pensions obligations.Ania Zalewska, Professor of Finance, University of BathLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/841362017-09-15T13:19:35Z2017-09-15T13:19:35ZI predicted the last financial crisis – now soaring global debt levels pose risk of another<figure><img src="https://images.theconversation.com/files/186197/original/file-20170915-8081-k338ri.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">shutterstock.com</span></span></figcaption></figure><blockquote>
<p>There are none so blind as those who will not see.</p>
</blockquote>
<p>This phrase may have <a href="http://www.actualfreedom.com.au/richard/abditorium/nonesoblind.htm">religious roots</a>, but there is no better way to describe the dominant sect in economics today than as wilfully blind. A decade after the 2007-08 crisis, most still repeat the mantra that it <a href="http://qpol.qub.ac.uk/decade-from-global-financial-crash/">could not have been predicted</a>.</p>
<p>Nonsense. The <a href="http://keenomics.s3.amazonaws.com/debtdeflation_media/2007/03/SteveKeenDebtReportNovember2006.pdf">data</a> that showed what would cause the crisis, and <a href="https://www.intheblack.com/articles/2015/07/07/6-economists-who-predicted-the-global-financial-crisis-and-why-we-should-listen-to-them-from-now-on">arguments</a> by non-mainstream economists that one would occur, were available before it hit. There was a runaway bubble in asset markets caused by too much credit being created by banks. </p>
<p>Credit – your capacity to buy something with money borrowed from a bank, rather than from your own cash – is exactly equal to the increase in private debt every year. The bigger this is compared to a country’s GDP (economic output), the more the economy is dependent on credit; and the bigger the accumulated debt is when compared to GDP, the more likely it is that a reduction in credit will cause an economic crisis.</p>
<h2>The data is incontrovertible</h2>
<p>The data, if you look at it, is incontrovertible – especially if you consider the epicentre of the 2008 crisis, the US, in historical context. The Great Depression triggered by the crash of 1929 was preceded by a margin-debt-fuelled bubble on the US stock market, with private debt blowing out during the crisis and then collapsing. That’s exactly what happened in 2007-08 – only with mortgage debt also getting in on the act.</p>
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<p>Private debt affects the economy in two ways: the higher debt is, relative to GDP, the more that a change in credit impacts on total demand. And credit adds to total demand by allowing people to spend more than just the money they currently have.</p>
<p>The correlation between credit and employment in the US is staggering. This is not just because <a href="http://newcityagenda.co.uk/wp-content/uploads/2017/06/New_City_Agenda_Professor_Steve_Keen_08.03.17_FINAL.pdf">it is so big</a> (the correlation coefficient is 0.8 on a scale of -1 to +1), but because according to mainstream economists <a href="http://press.princeton.edu/titles/6817.html">such as Ben Bernanke</a>, the correlation should be close to zero.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/186167/original/file-20170915-8093-18krprj.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img alt="" src="https://images.theconversation.com/files/186167/original/file-20170915-8093-18krprj.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/186167/original/file-20170915-8093-18krprj.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=472&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/186167/original/file-20170915-8093-18krprj.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=472&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/186167/original/file-20170915-8093-18krprj.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=472&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/186167/original/file-20170915-8093-18krprj.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=594&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/186167/original/file-20170915-8093-18krprj.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=594&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/186167/original/file-20170915-8093-18krprj.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=594&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Steve Keen</span>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<p>Bernanke, who got the job as head of the US central bank because he was supposed to be the expert on what caused the Great Depression, didn’t even consider similar data that was available at the time, nor 1930s economist <a href="https://campus.fsu.edu/bbcswebdav/users/jcalhoun/Courses/Growth_of_American_Economy/Chapter_Supplemental_Readings/Chapter_23/Fisher-The_Debt_Deflation_Theory.pdf">Irving Fisher’s thesis</a>, which pointed the finger at the bursting of asset bubbles. Bernanke <a href="http://press.princeton.edu/titles/6817.html">believed</a> that credit “should have no significant macroeconomic effects”.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/186168/original/file-20170915-8093-1y1d94i.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img alt="" src="https://images.theconversation.com/files/186168/original/file-20170915-8093-1y1d94i.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/186168/original/file-20170915-8093-1y1d94i.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=448&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/186168/original/file-20170915-8093-1y1d94i.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=448&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/186168/original/file-20170915-8093-1y1d94i.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=448&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/186168/original/file-20170915-8093-1y1d94i.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=563&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/186168/original/file-20170915-8093-1y1d94i.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=563&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/186168/original/file-20170915-8093-1y1d94i.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=563&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">Steve Keen</span>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span>
</figcaption>
</figure>
<p>Empirically, this is manifestly untrue, but economists turn a blind eye to this data because it doesn’t suit their preferred model of how banks operate. They model banks as if they are intermediaries that introduce savers to borrowers, not as originators of both money and debt. This deliberate blindness was, in a sense, excusable before the crisis. But it’s unforgivable after it – especially since central banks are actually coming out now and saying that this “Loanable Funds” model <a href="http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf">is a myth</a>.</p>
<p>Central Banks have therefore learnt something from the crisis, but academic economists are, in the main, trying to go backwards to their defence that this crisis “could not have been predicted”.</p>
<h2>Crisis prediction</h2>
<p>In fact, <a href="http://voxeu.org/article/no-one-saw-coming-or-did-they">it was predicted</a>, by economists who take banks, debt and money seriously, such as Ann Pettifor, Wyne Godley, and me. Using the same analysis today, I don’t expect a crisis in the US and UK in the near future. I do expect stagnation like that which Japan has experienced since its asset bubble economy <a href="http://www.nytimes.com/2005/12/25/business/yourmoney/take-it-from-japan-bubbles-hurt.html?mcubz=0">burst back in 1990</a>. </p>
<p>There will be revivals and reversals, but not an outright crisis because a prerequisite for that is very high levels of credit. While the overhang of private debt from the last crisis persists, credit-based demand will be anaemic compared to pre-crisis levels.</p>
<p>Instead, crises are likely in countries which side-stepped trouble in 2007 by continuing their private debt bubbles. The pre-eminent candidate here is China, whose <a href="http://www.telegraph.co.uk/business/2017/08/05/fresh-fears-chinas-debt-bubble-could-burst/">credit bubble</a> is easily the fastest growing in the history of capitalism. It will have the company of South Korea, Canada, Australia, Belgium, and a number of others. </p>
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<p>So there won’t be another collapse like Northern Rock in the UK or Washington Mutual in the US. But mainstream economists need to quit sticking their heads in the sand over the relationship between private debt bubbles.</p>
<p>The future offers some hope that this is beginning to change. Some prominent mainstreams economists are now doing some serious navel-gazing at their models (people such as ex-president of the Minneapolis Federal Reserve <a href="https://docs.google.com/viewer?a=v&amp;pid=sites&amp;srcid=ZGVmYXVsdGRvbWFpbnxrb2NoZXJsYWtvdGEwMDl8Z3g6MTAyZmIzODcxNGZiOGY4Yg">Narayana Kocherlakota</a>, and chief economist at the World Bank <a href="https://paulromer.net/wp-content/uploads/2016/09/WP-Trouble.pdf">Paul Romer</a>). But more likely change will come from central banks, and the new generation of economists such as the students who established the <a href="http://www.rethinkeconomics.org/">Rethinking Economics movement</a> to address the real issues the world faces.</p><img src="https://counter.theconversation.com/content/84136/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steve Keen has received research funding from the Institute for New Economic Thinking (<a href="http://www.ineteconomics.org">www.ineteconomics.org</a>) and has consulted to the Governor&#39;s Woods Foundation (<a href="http://www.govwoods.org">www.govwoods.org</a>). He is affiliated with IDEA Economics (<a href="http://www.ideaeconomics.org">www.ideaeconomics.org</a>).</span></em></p>The UK and US may avoid another crash, but many other major economies look like they are on the brink.Steve Keen, Head of the School of Economics, History & Politics, Kingston UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/837472017-09-13T09:55:19Z2017-09-13T09:55:19ZHow finance workers are paying the price for the industry's profit<figure><img src="https://images.theconversation.com/files/185730/original/file-20170912-3737-onimz5.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">The industry has walked a tight rope to survive. Many have fallen along the way.</span> <span class="attribution"><span class="source">shutterstock.com</span></span></figcaption></figure><p>A job in banking and insurance used to be a most sought-after prize <a href="https://books.google.es/books?id=jgzkj_PV1AEC&amp;printsec=frontcover&amp;dq=gregor+gall+fighting+for+rights+and+representation&amp;hl=en&amp;sa=X&amp;ved=0ahUKEwjhwbO5653WAhUKmrQKHQXLBQ4Q6AEIKDAA#v=onepage&amp;q=gregor%20gall%20fighting%20for%20rights%20and%20representation&amp;f=false">for many working class school leavers</a>. Not only was it a clean and safe white-collar job with long-term employment security, it also offered the prospect of a career and a good pension. But the financial crisis of 2007-08 has put an end to all that for good. </p>
<p>No longer are there widely available secure jobs with career prospects and good pensions for the majority in banking and finance. Indeed, no longer is banking and finance even an inviting prospect for many middle-class university graduates. Today, they prefer to go into the professions of accounting, law and public relations, or work for new, upstart technology companies <a href="https://www.hunted.com/blog/7-financial-services-recruitment-companies-with-big-ambitions-for-2016/">like those in fintech</a>. Pay, conditions and prospects are much better there, as is the public perception and wider status of those industries. </p>
<p>When bonuses were cut and regulated following political pressure after the financial crash, those disproportionately affected were the lower grade finance workers who relied on bonuses to make their wages up to something <a href="http://www.redflag.org.uk/frontline/july09/financesectgo.html">close to a reasonable level of income</a>. Those with telephone number bonuses could easily fall back on their basic salaries of hundreds of thousands of pounds. In the meantime, criminal prosecutions against the managers who encouraged reckless activity and their underlings who engaged in reckless activity have been almost non-existent.</p>
<p>The consequence of this, as I found when researching <a href="http://www.palgrave.com/gb/book/9781137395375">my new book</a> on employment relations in the post-crash period, is that the banking and insurance sector can no longer be an engine of social mobility from the working class to the middle class. Nor can it be any longer a generator of secure, satisfying employment for the many employed within it. </p>
<p>The reaction of employers in banking, finance and insurance to the financial crisis has been the introduction of massive job cuts, oppressive performance management systems and reduced real value of pay, and an end to decent pensions. In my book, I categorise the experience of employees as: flight, fright, fight and falling-in-line. </p>
<h2>No guarantees</h2>
<p>For a sector of around one million employees, the numbers leaving banking and insurance through redundancy programmes has been astronomically high. As I calculated, from 2007 to 2017, major insurance company Aviva reduced its workforce in Britain from 21,000 to 15,000, with Barclays bank cutting its British headcount from 103,000 to 71,000. HSBC bank went from 67,000 to 43,000, Lloyds banking from 140,000 to 73,000, Northern Rock bank from 6,500 to 2,500, RBS from 120,000 to 65,000 and Zurich from 10,000 to 4,000.</p>
<p>The impact of this flight has been that those left in those organisations in banking and insurance now have to do more with less. But they do so under very different circumstances. The introduction of oppressive performance management systems means that workers must achieve a growing number of targets to be eligible for pay rises. But no pay rises are guaranteed. </p>
<p>It has not been uncommon for a quarter of workers in a particular company in any one year to receive no pay increase at all, meaning a cut in the real value of their pay. On top of that, the level of unpaid overtime has increased significantly as workers come in early, stay late and work through their breaks to chase often unachievable targets. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/185732/original/file-20170912-3750-11h3uta.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/185732/original/file-20170912-3750-11h3uta.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/185732/original/file-20170912-3750-11h3uta.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/185732/original/file-20170912-3750-11h3uta.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/185732/original/file-20170912-3750-11h3uta.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/185732/original/file-20170912-3750-11h3uta.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/185732/original/file-20170912-3750-11h3uta.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Overtime has got worse.</span>
<span class="attribution"><span class="source">shutterstock.com</span></span>
</figcaption>
</figure>
<p>Performance management systems also allow companies to manage workers out of the organisation without compensation <a href="http://www.stuc.org.uk/files/Document%20download/Workplace%20tyranny/STUC%20Performance%20Management%20Executive%20Summary%20final.pdf">for what they deem to be under-performance</a>. And if staff in banking, finance and insurance manage to stay the course, no pot of gold awaits them upon retirement anymore. Almost all final salary pension schemes have been ended, replaced by inferior ones without a guaranteed level of decent benefits.</p>
<h2>Fire of discontent</h2>
<p>No longer do many workers in banking, finance and insurance feel happy in their jobs as the many surveys of union members I’ve analysed show. Many feel abused and under-valued by their employers. On top of this, they also feel despised by the public as they are tarred with the same brush as the bankers that set off the financial crisis in the first place. That bonuses and compensation packages for top level managers and executives in banking, finance and insurance have never experienced the kind of austerity that their underlings have has merely added fuel to this fire of discontent. </p>
<p>The deterioration in the sector’s post-crisis working conditions led to a stampede out the door when (voluntary) redundancy programmes were on offer. And the power of unions in the sector is also on the decline. Most have a partnership approach, which guarantees employee representation a seat at the table with management and is based on the idea that employees and employers have mutual interests (which they often do not). </p>
<p>At the same time, collective bargaining powers have commonly been downgraded and replaced by mere consultation. With redundancy often seen as the more appealing option, union membership has experienced something of a downward spiral. This does little to help them become stronger, which is exactly what they need if they are to increase their memberships.</p>
<p>For those that remain, the combination of flight (redundancies) and fright (oppressive management) has led to much falling in line whereby workers reluctantly submit to management diktat as best they can. It seems there is very little they can do to fight back. Banking will no longer offer a route to social mobility – and <a href="https://theconversation.com/banking-sector-will-be-ground-zero-for-job-losses-from-ai-and-robotics-83731">the switch to automation will only compound this</a>.</p><img src="https://counter.theconversation.com/content/83747/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Gregor Gall is editor of the Scottish Left Review and director of the Jimmy Reid Foundation. He is not a member of any political party.</span></em></p>Banking used to be an engine of social mobility and a generator of secure, satisfying employment for the many gainfully employed in it.Gregor Gall, Professor of Industrial Relations, University of BradfordLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/834772017-09-12T11:14:46Z2017-09-12T11:14:46ZSix charts that show how much the world has changed since the 2007-08 financial crisis<p>Ten years ago, fretting depositors formed lengthy queues in front of Northern Rock bank branches <a href="http://news.bbc.co.uk/1/hi/business/6996136.stm">across the UK</a> after news broke that it needed support from the Bank of England. The country’s fifth-largest mortgage lender, it was in real danger of running out of cash. People were anxious to withdraw their money. They all managed to do so. But not without the intervention of the Bank of England, the UK’s central bank and lender of last resort, <a href="http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/11032772/The-rise-and-fall-of-Northern-Rock.html">which provided emergency funding</a>.</p>
<p>It was the moment the financial crisis first became real to many. Deep-rooted issues with the global financial system had become evident <a href="https://theconversation.com/the-day-the-world-changed-a-former-trader-on-how-the-credit-crunch-kicked-off-82019">a few months previously</a> with the freezing of lending between banks. It meant that credit was disappearing and institutions like Northern Rock which relied heavily on short-term borrowing from other banks to finance their activities (like providing mortgages) had no chance of survival. The Bank of England had to act and make billions of pounds available to save them from collapse.</p>
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Read more:
<a href="http://theconversation.com/the-day-the-world-changed-a-former-trader-on-how-the-credit-crunch-kicked-off-82019">'The day the world changed' – a former trader on how the credit crunch kicked off</a>
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<p>The reasons behind the deep freeze of the interbank market are by now <a href="http://www.economist.com/node/12342237">well-known</a>. Irresponsible levels of lending by US banks in the form of subprime mortgages led to large numbers of households defaulting on their mortgages when new higher rates were introduced. Then the growing tide of defaults affected house prices as banks dumped repossessed houses onto the market. </p>
<p>Many of these mortgages were bundled together into loans known as mortgage-backed securities, which banks across the globe were heavily invested in buying and selling. So when the value of mortgages plummeted this also destroyed the value of these securities. Banks suddenly found one of their key assets diminished. As a result, they held on to whatever cash they had. The interbank market froze – and not just in the US. The world’s intertwined financial system ensured that fear spread throughout the Western money markets.</p>
<p>The consequences of the resulting financial crisis were very real. In some ways, the world is still dealing with its ripple effects ten years later. The following six graphs attest to this. </p>
<h2>1. GDP</h2>
<p>One of the main indicators of a country’s living standards is obtained by measuring its economic output (adjusted for price changes) and dividing this by the country’s population. This is known as real gross domestic product (GDP) per person. As the financial crisis unfolded, it caused dramatic falls in real GDP in many countries. </p>
<p>By 2008 the UK, US and Japan were all in recession – their real output had shrunk. Germany followed. Whereas most countries resumed positive growth rates by 2010, Greece continued facing a painful recession for several more years.</p>
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<h2>2. Unemployment</h2>
<p>Recessions correspond to lower levels of economic activity so it is more difficult for people to find jobs. In the UK, the unemployment rate increased from 5.4% in 2007 to 8.1% in 2011. In Greece, where debt levels were very high even before the crisis hit, unemployment peaked at 27.5% in 2013 and has stubbornly stayed above 20% since. </p>
<p>With the help of monetary policy and measures to instil confidence in financial markets, unemployment in the UK, US, Japan and Germany was below 5% by 2016.</p>
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<h2>3. Interest rates</h2>
<p>The main tool used in the conduct of monetary policy is the interest rate. Following the financial crisis, and among other policy measures, central banks have <a href="https://theconversation.com/what-low-interest-rates-have-done-for-the-world-and-the-likely-effects-of-a-rise-51928">slashed their interest rates</a> in a bid to boost economic activity. The idea is that low rates give little incentive to save and higher incentive to borrow cheaply and invest, thereby getting the economy going.</p>
<p>Japan is the only country that had low interest rates before the recession as it was already dealing with a stagnant economy, yet reduced them further following the crisis. </p>
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<h2>4. Government spending</h2>
<p>To deal with a recession, governments can also consume and invest more themselves. To spend more, however, they need to borrow more than they already do, as raising taxes during a recession to finance government spending would further hurt economic activity. </p>
<p>Additional borrowing by governments has been a controversial issue following the crisis. Many governments chose to pursue austerity policies, instead. </p>
<p>The next graph shows that in the UK, government spending increases post-crisis were, on average, lower than before the crisis. In Greece, there were reductions in public spending. And in the US, too, albeit lower reductions. </p>
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<h2>5. Government debt</h2>
<p>Post-crisis, levels of government debt have in most cases shot up. The recession meant that tax revenues were lower than planned and borrowing increased to makeup for the shortfall. In the UK, debt (as a proportion of GDP) more than doubled, albeit from a very low level by international standards. In the US, the debt ratio exceeded 100% and in Japan it exceeded 200%. Greece is heading in this direction too.</p>
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<h2>6. Current accounts</h2>
<p>A government’s current account includes the value of its exports to the rest of the world minus its imports from it, as well as net income from investments abroad. It’s an important indicator of an economy’s health as it shows whether a country is a net borrower or a net lender.</p>
<p>Greece’s deficit almost disappeared after the crisis, as falling incomes meant fewer imports. In contrast, in the UK, despite the fall in the value of the pound internationally, the current account deficit has increased. Germany’s surplus has overshadowed that of Japan’s every year since 2004 and the difference has become even larger after the crisis.</p>
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<p>Not all the trends observed in the graphs can be directly attributed to the financial crisis. But the crisis did affect the world’s advanced economies in profound ways. Indirectly, it may even have led to tectonic shifts in how societies view markets, trade, globalisation, politicians, experts and each other. It remains to be seen whether alternatives such as Brexit or the US administration’s protectionist agenda, can deliver what their proponents are hopeful of.</p><img src="https://counter.theconversation.com/content/83477/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alex Mandilaras does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The 2007-08 financial crisis affected the world's advanced economies in profound ways and the ripple effects continue to today.Alex Mandilaras, Senior Lecturer in Economics, University of SurreyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/820192017-08-07T14:03:29Z2017-08-07T14:03:29Z'The day the world changed' – a former trader on how the credit crunch kicked off<figure><img src="https://images.theconversation.com/files/181230/original/file-20170807-25565-i55vam.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">shutterstock.com</span></span></figcaption></figure><p>When I received a phone call from a trader colleague at Merrill Lynch on August 9 2007, I was in the middle of chopping wood in the Swedish countryside. As always, I had my mobile on me in case of an emergency. </p>
<p>I answered the call to a frenzied account of an extraordinary development in the financial markets. My colleague kept repeating that things were “crazy” and “completely mad”. At the time, there was nothing in what he said that made me worried about my trading position, let alone the global financial system. Rather, it was the market prices, quotes and numbers that he listed that did not make sense at all. </p>
<p>Put together, it seemed as if all banks, suddenly, had become desperate for cash. The reason soon became apparent: French bank BNP Paribas had barred investors from accessing money in funds with subprime mortgage exposure, <a href="https://www.ft.com/content/9a4cabc4-464d-11dc-a3be-0000779fd2ac">citing</a> a “complete evaporation of liquidity”. It was the start of the credit crunch. </p>
<p>A financial crisis tends to be associated with fears of a bank run. Picture long queues outside banks, such as during the Great Depression following the 1929 Wall Street crash. If customers desperately begin to withdraw their deposits from a bank, it can quickly turn into a self-fulfilling prophecy. If you think that others will become afraid that the bank will run out of cash, it might be rational to empty your own savings account first. And so, for many, scenes of long queues outside branches of UK bank Northern Rock <a href="http://www.telegraph.co.uk/news/uknews/1563266/The-Northern-Rock-crisis-explained.html">in September 2007</a> is still their earliest memory of the credit crunch and the global financial crisis.</p>
<p>Before the fear of a bank run spreads to the public, however, the atmosphere on the trading floors has already changed. Trading turns into a situation in which the hot potato is passed around from trader to trader, from bank to bank. Lending money is a risky business and nobody wants the borrower to default. As a precaution, banks desperately try to borrow money from the others before they stop lending. Nobody wants to get burnt by being left holding that hot potato. </p>
<p>Parts of the money markets had already begun to dry up with the demise of the US sub-prime mortgage market <a href="http://www.nytimes.com/2007/02/23/business/worldbusiness/23bank.html">around February 2007</a>. Some hedge funds and lenders had reported serious losses – and this malaise had spread to European markets. Then followed <a href="http://www.reuters.com/article/us-bnpparibas-subprime-funds-idUSWEB612920070809">the news</a> that BNP Paribas had frozen €1.6 billion of funds, citing US subprime mortgage sector problems. </p>
<p>BNP had always played a big role in the trading community and had made markets in everything I traded: foreign exchange, bonds and interest rate derivatives. They were also French – and the French banks were famous for hiring the best programmers and mathematicians as analysts and traders. If they did not know how to value their portfolios, who did? When I received the phone call, the news flash had just happened and the game of musical chairs had begun.</p>
<p>Being a short-term interest rate trader had not been particularly glamorous before August 9 2007. Our desk traded a range of instruments that were important for the financial system, but not interesting and complex enough to represent the forefront of financial innovation. Other trading desks enjoyed considerably more prestige. Then everything was turned upside down. </p>
<p>Suddenly, the spotlight fell on us. Everything we did had a direct link to the money market between banks and the benchmark linked to it, <a href="https://theconversation.com/the-scandal-might-be-over-but-libor-ethics-remain-fundamentally-flawed-77412">LIBOR</a>, so our desk evolved into a place people turned to in order to get an idea of what was going on with the market. Which bank was rumoured to be in the worst shape? Which bank seemed most desperate to borrow? Which bank had been ordered to throw in the towel and temporarily suspend its market-making activity? Which bank had refused to deal with which other bank for fear of insolvency? </p>
<p>The rest is, of course, history: the collapse of the bank Lehman Brothers in September 2008 and the most severe financial crisis since the Great Depression (not to mention the <a href="https://theconversation.com/qanda-what-is-the-libor-scandal-and-why-does-it-matter-45662">LIBOR scandal</a>). Even today, central bankers, regulators and other policy makers talk about measures that ought to be taken to avoid another “Lehman moment”. What they refer to is a situation in which the entire global financial system is on the brink of total collapse. </p>
<p>August 9 2007 will not go down in history as the day the world ended. Rather, to cite the former <a href="https://www.theguardian.com/business/2011/dec/01/credit-crunch-pinpointed-august-2007">Northern Rock boss Adam Applegarth</a> it will be remembered as the “day the world changed”.</p><img src="https://counter.theconversation.com/content/82019/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexis Stenfors is the author of Barometer of Fear: An Insider’s Account of Rogue Trading and the Greatest Banking Scandal in History.</span></em></p>Recalling August 9 2007 – the start of the credit crunch and global financial crisis.Alexis Stenfors, Senior Lecturer in Economics and Finance, University of PortsmouthLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/807852017-07-31T21:30:57Z2017-07-31T21:30:57ZIs Congress' plan to save Puerto Rico working?<figure><img src="https://images.theconversation.com/files/180397/original/file-20170731-22126-nju9vc.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">Puerto Ricans are increasingly fed up with austerity. </span> <span class="attribution"><span class="source">AP Photo/Danica Coto</span></span></figcaption></figure><p>A year ago, Congress <a href="https://www.congress.gov/bill/114th-congress/house-bill/5278/text">cobbled together a plan</a> to try to save Puerto Rico from its US$123 billion debt and pension crisis without costing American taxpayers a penny. </p>
<p>The law, signed by former President Barack Obama on June 30, 2016, effectively steered Puerto Rico into bankruptcy-like proceedings in federal court to prevent a massive default, while saddling the commmonwealth with an oversight board to ensure it put its fiscal house in order.</p>
<p>Though the vote was bipartisan, critics called it a “Band-Aid” that would do little to solve Puerto Rico’s core problems: unsustainable debt that has kept the country mired in recession for almost a dozen years. As Democratic Sen. Bob Menendez, the plan’s fiercest foe, put it: </p>
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<p>“Mark my words: if we don’t seize this opportunity to address this crisis in a meaningful way, we’ll be right back here in a year from now picking up the pieces.”</p>
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<p>So a year later, have his words proven prescient? Or has the law – known by the acronym PROMESA – lived up to <a href="https://juntasupervision.pr.gov/index.php/en/home/">its promise</a> to “create the necessary foundation for economic growth and to restore opportunity to the people of Puerto Rico”?</p>
<p>The <a href="https://juntasupervision.pr.gov/index.php/en/home/">Financial Oversight and Management Board</a> that Congress established to manage Puerto Rico’s finances released its first progress report on July 31. At Hunter College’s Center for Puerto Rican Studies, we’ve also been <a href="https://centropr.hunter.cuny.edu/education/puerto-rico-crisis-timeline">keeping score</a>, as well as tracking the <a href="https://centropr.hunter.cuny.edu/events-news/events/conferences/puerto-ricopuerto-ricans/diaspora-summit/unfolding-humanitarian">human side of the crisis</a>. </p>
<h2>Out of options</h2>
<p>Before Congress passed the <a href="https://www.congress.gov/bill/114th-congress/house-bill/5278/text">Puerto Rico Oversight, Management and Economic Stability Act</a> (PROMESA), the Caribbean island – located about 1,000 miles southeast of Miami – had run out of options. </p>
<p>The end of a <a href="https://www.law.cornell.edu/uscode/text/26/936">federal tax exemption</a> for U.S. companies to build factories in Puerto Rico <a href="https://taxfoundation.org/tax-policy-helped-create-puerto-rico-s-fiscal-crisis/">precipitated the crisis</a>, while the global financial meltdown in 2008 made it a <a href="https://theconversation.com/puerto-ricos-long-fall-from-shining-star-to-the-greece-of-the-caribbean-43097">whole lot worse</a>. Shut out of the credit markets after its debt <a href="http://www.reuters.com/article/munis-puertorico-ratings-idUSL2N0LC1F820140207">was downgraded</a> to “junk,” a government default loomed.</p>
<p>While U.S. municipalities can declare bankruptcy via <a href="http://www.investopedia.com/terms/c/chapter9.asp">Chapter 9</a>, <a href="https://www.bloomberg.com/view/articles/2015-07-08/puerto-rico-s-colonial-power-struggle">Congress in 1984 excluded Puerto Rico</a> from seeking its relief for reasons that still <a href="https://www.bloomberg.com/view/articles/2015-12-03/bankruptcy-was-option-for-puerto-rico-before-congress-goof">elude most analysts</a>, including me.</p>
<p>But with PROMESA, Puerto Rico got the breathing room for debt restructuring it so desperately needed. To judge the law’s effectiveness, however, we must determine how far it’s come in resolving the commonwealth’s three key problems: too much debt, a budget that bleeds red and – most importantly – jump-starting a battered economy. </p>
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<h2>A mountain of debt</h2>
<p>One of the primary goals of PROMESA was to steer negotiations with creditors and eventually lead to a restructuring of $74 billion in <a href="http://www.aafaf.pr.gov/assets/planfiscal13demarzo2017.pdf">crushing debt</a> and $49 billion in <a href="http://www.reuters.com/article/us-puertorico-debt-budget-idUSKBN18R3C8">unfunded pension obligations</a>. </p>
<p>In May, Puerto Rico formally <a href="https://www.nytimes.com/2017/05/03/business/dealbook/puerto-rico-debt.html?_r=0">filed for bankruptcy</a> under the special court process PROMESA created, the first time a U.S. state or territory has done so. This will allow the island to significantly reduce how much it must pay its creditors – such as mutual funds, hedge funds and individual Puerto Ricans and Americans – and retirees to whom it owes pensions. Ultimately, a New York federal judge will determine who gets what. </p>
<p>Puerto Rico will also have to <a href="http://www.reuters.com/article/us-puertorico-debt-lawsuit-idUSKBN17Y0G3">fend off several lawsuits</a> filed by creditors and bond insurers, some of which allege the debt-cutting plans violate the U.S. Constitution.</p>
<p>The seven-member Financial Oversight and Management Board should be commended for being sensible toward the need to restructure the island’s unsustainable debt levels. That process, so far, is working as intended but is far from conclusive.</p>
<h2>Balancing the budget</h2>
<p>That brings us to fiscal policy and the budget. </p>
<p>In October 2016, the Financial Oversight and Management Board <a href="http://www.reuters.com/article/us-puertorico-oversight-deficit-idUSKBN1491ZB">revealed</a> that Puerto Rico faced a $67.5 billion budget gap through 2026. In March, it <a href="https://www.nytimes.com/2017/03/13/business/puerto-rico-debt-crisis-oversight-board.html">approved a plan</a> submitted by Gov. Ricardo Rosselló to narrow the gap by about $40 billion over a decade by, among other things, cutting health care, reducing certain pension benefits by 10 percent and putting government employees on furlough.</p>
<p>Simply put, punishing austerity seems unavoidable, particularly as the population continues to decline, which makes the fiscal problem worse by reducing tax revenue. About 500,000 people <a href="https://centropr.hunter.cuny.edu/sites/default/files/PDF_Publications/State%20of%20Puerto%20Ricans-promo%202017.pdf">have left the island</a> since the crisis began, according to my center’s research.</p>
<p>That’s because <a href="http://www.pbs.org/newshour/bb/amid-new-austerity-measures-push-puerto-rico-restructure-debt/">austerity is already sinking deep</a> into the lives of Puerto Ricans. Funding to schools, hospitals and other essential services <a href="https://www.forbes.com/sites/debtwire/2017/03/22/puerto-rico-oversight-board-appears-doomed-to-recycle-failed-austerity-schemes/#1fa0656d2479">has been severely cut</a>, more than 150 schools have closed and teachers, doctors and scientists are part of the island’s exodus heading for the mainland. </p>
<p>The plan also calls for a sharp drop in debt payments to creditors – to about 25 cents on the dollar – until the bankruptcy court rules on final amounts. Yet, despite progress on debt restructuring, the Financial Oversight and Management Board has become the face of austerity. Public opinion, at times hopeful, has given way to a <a href="https://www.thenation.com/article/students-are-now-leading-the-resistance-to-austerity-in-puerto-rico/">growing chorus</a> of voices against austerity, protests and other forms of resistance to the undemocratic nature of the Financial Oversight and Management Board. </p>
<h2>The bigger challenge: Growing the economy</h2>
<p>Unfortunately, the fiscal plan’s austerity will make it harder to achieve the most important goal: sustainable economic growth. </p>
<p>Puerto Rico has endured a <a href="http://www.gdb-pur.com/economy/statistical-appendix.html">debilitating economic recession since 2006</a>, the year the tax incentive for U.S. companies ended, driving <a href="https://data.bls.gov/timeseries/LASST720000000000003">unemployment as high as 17 percent</a> (it’s currently 10 percent) and poverty to <a href="https://www.census.gov/programs-surveys/acs/library/keywords/prcs.All.html">about 46 percent</a>. It is estimated that up to <a href="http://www.univision.com/puerto-rico/wlii/noticias/pobreza/el-84-de-los-ninos-en-puerto-rico-vive-en-la-extrema-pobreza">84 percent of children live in poverty areas</a>. </p>
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<p>The austerity in the plan, based on the government’s own projections, is <a href="https://www.nytimes.com/2017/03/13/business/puerto-rico-debt-crisis-oversight-board.html">expected to reduce economic growth</a> of <a href="http://www.aafaf.pr.gov/assets/planfiscal13demarzo2017.pdf">2 to 3 percentage points annually</a> over the next five years. </p>
<p>With numbers like these, one would think that Congress would be hard at work devising urgent economic development measures to rapidly boost growth. Unfortunately, this has not happened. Congress has yet to act on a report prepared by a <a href="https://www.finance.senate.gov/imo/media/doc/Bipartisan%20Congressional%20Task%20Force%20on%20Economic%20Growth%20in%20Puerto%20Rico%20Releases%20Final%20Report.pdf">bipartisan task force</a> it set up as part of PROMESA, which laid out several key recommendations, such as shoring up Medicaid, extending the earned income tax credit to the island and supporting business development. The Financial Oversight and Management Board, in its report, <a href="https://juntasupervision.pr.gov/wp-content/uploads/wpfd/50/597eb4ede89ad.pdf">also encouraged Congress</a> to do more to stimulate Puerto Rico’s economy. </p>
<p>As for the Financial Oversight and Management Board and Puerto Rico’s government, not a single major economic development project has been presented to the board, even though PROMESA explicitly gives it power to <a href="https://www.congress.gov/bill/114th-congress/house-bill/4900/text#toc-HED24BE2EF47B4B8FAD4E70068F621883">fast-track “critical infrastructure” projects</a> that create jobs and jump-start the economy. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/180394/original/file-20170731-22136-rys30p.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/180394/original/file-20170731-22136-rys30p.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/180394/original/file-20170731-22136-rys30p.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/180394/original/file-20170731-22136-rys30p.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=400&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/180394/original/file-20170731-22136-rys30p.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=502&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/180394/original/file-20170731-22136-rys30p.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=502&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/180394/original/file-20170731-22136-rys30p.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=502&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Puerto Rico Gov. Ricardo Rossello celebrates the results of a referendum on statehood in June.</span>
<span class="attribution"><span class="source">AP Photo/Carlos Giusti</span></span>
</figcaption>
</figure>
<h2>Growing into a state?</h2>
<p>The issue is now getting tangled up in Puerto Rico’s separate (and controversial) <a href="http://www.pbs.org/newshour/bb/congress-steps-puerto-rico-reignites-statehood-debate/">bid for statehood</a>. </p>
<p>In a <a href="http://www.cnn.com/2017/06/09/us/puerto-rico-statehood-vote-2017/index.html">recent referendum</a> plagued by poor turnout, Puerto Ricans voted to become the 51st state, which some argue is necessary to resolve its fiscal woes because it’ll lead to a lot of benefits. The General Accounting Office estimated that parity in federal programs will add up to <a href="http://thehill.com/blogs/congress-blog/civil-rights/203131-with-gao-report-momentum-builds-for-puerto-rican-statehood">$10 billion in transfers to the island</a>. But <a href="http://thehill.com/latino/340568-puerto-rico-faces-off-with-bondholders-over-statehood">bondholders and others are objecting</a> to Congress’ consideration of statehood until the debt crisis is over. </p>
<p>They’re right about one thing: The likelihood that Congress would consider granting statehood to a bankrupt state or as a solution to the economic challenge via some kind of bailout is slim to say the least. For advocates of statehood, as it is for advocates of other political status options, the surest way to advance their cause is a revival of Puerto Rico’s economy. </p>
<p>Restructuring the debt and balancing the budget are important steps in that direction, but austerity alone will not solve the problem, just as <a href="https://www.theguardian.com/business/2016/may/27/austerity-policies-do-more-harm-than-good-imf-study-concludes">it hasn’t in Greece</a>. Puerto Rico cannot simply cut its way to solvency. It needs growth.</p>
<p>And to that end, Puerto Rico’s government could begin planning economic initiatives with the private sector, while Congress could act on the task force report, modest steps that could help the island get back on its feet. The <a href="https://centropr.hunter.cuny.edu/research-education/research/data-center/research-briefs/health-insurance-coverage-among-puerto">data clearly show</a> that it will only become a lot more expensive and politically sensitive. </p>
<p>In fact, solving the economic and fiscal crisis, while mitigating the impact of austerity on the most vulnerable populations, might be the most certain pathway to (finally) solving the political status question.</p><img src="https://counter.theconversation.com/content/80785/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Edwin Meléndez does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A year after Congress passed its plan to fix Puerto Rico's US$123 billion debt and pension crisis, little has changed for the lives of Puerto Ricans.Edwin Meléndez, Professor of Urban Affairs and Planning and Director of the Center for Puerto Rican Studies, Hunter CollegeLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/809082017-07-31T13:19:40Z2017-07-31T13:19:40ZHow to reshape the financial system? First ditch the idea of the free market<figure><img src="https://images.theconversation.com/files/180357/original/file-20170731-4035-1y35e4j.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">shutterstock.com</span></span></figcaption></figure><p>Ten years ago the financial system collapsed and governments around the world <a href="https://www.theguardian.com/business/2008/oct/13/creditcrunch-marketturmoil1">intervened</a> to save it. Much of the subsequent legislation, regulation and angst has attempted to make the system less risky so it does not collapse again. But few have asked a more fundamental question: what is the purpose of the financial system and does it do what it’s supposed to do? </p>
<p>Ten years on and the global financial system remains chronically dysfunctional. My concern is not that it collapses again but that it continues on its current course. </p>
<p>Yet an alternative way of doing things <a href="http://www.palgrave.com/us/book/9781137560605">is possible</a>. Over many years the finance industry has developed a set of powerful tools which could be used to improve well-being and solve our environmental problems. For example, to avoid dangerous climate change, the required rapid shift away from fossil fuels requires enormous levels of investment into low carbon infrastructure. </p>
<p>We mostly know how to do this technically, and the funds are available; there is a savings surplus where <a href="http://www.cnbc.com/2016/06/29/there-are-now-117-trillion-dollars-worth-of-bonds-with-negative-yields.html">trillions of dollars</a> are sitting in government bonds earning negative returns that could be mobilised into the low carbon economy. So why is this investment not happening at the scale required?</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/180363/original/file-20170731-15340-ix66eu.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/180363/original/file-20170731-15340-ix66eu.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=401&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/180363/original/file-20170731-15340-ix66eu.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=401&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/180363/original/file-20170731-15340-ix66eu.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=401&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/180363/original/file-20170731-15340-ix66eu.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/180363/original/file-20170731-15340-ix66eu.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/180363/original/file-20170731-15340-ix66eu.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">A sustainable future requires investment but the payoff is worth it.</span>
<span class="attribution"><span class="source">shutterstock.com</span></span>
</figcaption>
</figure>
<p>Instead, these powerful financial tools have been co-opted by the finance industry for the purpose of growing its own revenue and importance, with resultant collateral damage to society and the environment. </p>
<p>Blame is commonly attributed to the <a href="https://theconversation.com/how-neoliberalisms-moral-order-feeds-fraud-and-corruption-60946">neoliberal rule of the market</a>, <a href="https://theconversation.com/banking-crisis-signalled-end-of-greed-is-good-time-for-ceos-to-get-in-touch-with-inner-guru-31145">greed</a> and <a href="https://www.theguardian.com/business/2012/may/06/shout-rooftops-bank-deregulation-leads-to-disaster">deregulation</a>. </p>
<p>My diagnosis is different: financial markets are the creation of society, and we have set them up in the wrong way, based on faulty economic theories. Governments have outsourced the management of societies’ assets to the finance industry and set the industry the wrong incentives. So we need to rethink how we want our assets managed and reset the incentives to achieve this.</p>
<h2>Government power</h2>
<p>The tools of finance are powerful because they are used to allocate society’s capital, and this determines the future direction of the economy. So, <a href="https://www.imf.org/en/News/Articles/2015/09/28/04/53/sp030706">the Chinese government</a>, for example, has decided to direct finance, in co-ordination with other policies, towards manufacturing-export industries, and these sectors have rapidly grown. </p>
<p>In the UK economy, this decision has been given to the finance sector, which invests people’s savings, for example via pension funds and bank accounts. The justification is that free markets will make the best decision on where to allocate resources. The most efficient users of capital will be able to pay the best return so everyone will be better off. </p>
<p>Yet, the reality is that we don’t have free financial markets. People mostly save via capital markets because they are induced to do so by the government. The most important financial variable is the interest rate, which is set by a government agency, the largest asset class are government bonds, only a restricted group of government-mandated banks can accept deposits, and government regulation shapes the way markets work. For example there are over 100,000 pages of pension regulations alone. Plus, the whole system owes <a href="http://couragetoactbook.com/">its existence to the 2008 bail out</a>. So, seeing that financial markets are not free, the theory that free markets are efficient and reflect peoples’ social preferences is not applicable.</p>
<p>It is evident that the financial system does not efficiently allocate people’s money. The finance sector has grown to an enormous size and looks anything but efficient: half of all savings are ultimately <a href="https://www.thersa.org/discover/publications-and-articles/reports/seeing-through-the-british-pension-system">eaten up by charges</a>, less than 4% of savings <a href="http://www.palgrave.com/us/book/9781137560605">are actually invested at all</a> (the rest spends its life as perpetually traded abstract financial assets), the system is <a href="https://www.penguin.co.uk/books/187623/the-shifts-and-the-shocks/">prone to asset bubbles and crashes</a>, returns have been driven down to close to zero <a href="http://www.palgrave.com/us/book/9781137560605">making a pension unaffordable</a>, the level of debt in the economy <a href="http://press.princeton.edu/titles/10546.html">has increased unsustainably</a>. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/180362/original/file-20170731-15340-ygv9yl.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/180362/original/file-20170731-15340-ygv9yl.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=401&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/180362/original/file-20170731-15340-ygv9yl.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=401&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/180362/original/file-20170731-15340-ygv9yl.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=401&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/180362/original/file-20170731-15340-ygv9yl.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/180362/original/file-20170731-15340-ygv9yl.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/180362/original/file-20170731-15340-ygv9yl.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=503&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Only a small percentage of savings are invested in the real economy.</span>
<span class="attribution"><span class="source">shutterstock.com</span></span>
</figcaption>
</figure>
<p>Instead of stewarding the corporates they oversee, investment managers encourage corporates to make short-term decisions <a href="https://www.ft.com/content/d583baa2-823f-11e5-8095-ed1a37d1e096?mhq5j=e1">to boost their share price</a>. The example of banks’ behaviour in the run up to the financial crisis was a dramatic manifestation. More pernicious are incentives for companies to return money to shareholders rather than invest in staff or infrastructure, undermining social cohesion (through inequality) and the long-term prospects of the economy.</p>
<h2>Deciding what we want</h2>
<p>So how could we achieve a better system? The government currently supports, promotes and sets incentives for finance based on an inapplicable economic theory to perpetuate a system that doesn’t work. Instead, we need to decide on what we want finance to do and set incentives to achieve the outcomes we want. </p>
<p>For example, in return for the continued support of the finance system, the finance industry should have to demonstrate that it is socially useful. Banks that have the right to create money and are guaranteed by governments should preference lending to create jobs and other social benefits (the proportion of lending to the “real” economy by banks is negligible). </p>
<p>To benefit from a tax rebate, pensions and savings products should have to demonstrate a positive social benefit or invest in sustainable infrastructure and R&amp;D. The sustainable finance tools <a href="http://wedocs.unep.org/bitstream/handle/20.500.11822/20716/The_Financial_System_We_Need_From_Momentum_to_Transformation.pdf?sequence=1&amp;isAllowed=y">to do this exist</a> and have been tried and tested over an extended period.</p>
<p>Defining what is socially useful is problematic, but it is not a problem that we can duck. Currently the government support for finance has an ethical basis – theoretically efficient free markets to ensure that the economy runs at maximum potential. This may be a worthy value, but it does not apply to our current non-free financial markets. We need to decide what values we want finance to embody, and then set the rules to achieve these.</p><img src="https://counter.theconversation.com/content/80908/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Nick Silver is author of &quot;Finance, Society and Sustainability: How to Make the Financial System Work for the Economy, People and Planet&quot; and a director of Radix, the think tank of the radical centre, and of Climate Bonds Initiative.</span></em></p>The finance industry has developed a powerful set of tools over the years, which could be used to improve well-being and solve our environmental problems.Nick Silver, Honorary Senior Visiting Fellow at CASS, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/803532017-07-11T01:05:35Z2017-07-11T01:05:35ZWhy we need to save the Consumer Financial Protection Bureau<p>Republicans in <a href="https://www.forbes.com/sites/jimhenry/2017/05/30/congressional-critics-gunning-for-consumer-financial-protection-bureau/#24b1e09167ab">Congress</a> and the <a href="https://consumerist.com/2017/03/20/white-house-wants-authority-to-fire-consumer-protection-chief/">White House</a> have been very blunt about their desire to gut the <a href="https://www.consumerfinance.gov">Consumer Financial Protection Bureau</a> (CFPB). </p>
<p>The agency was launched in 2011 in the aftermath of the financial crisis as part of the <a href="https://www.sec.gov/about/laws/wallstreetreform-cpa.pdf">Dodd-Frank Wall Street Reform and Consumer Protection Act</a>. The goal was to protect consumers from deceptive or misleading practices in the financial industry. </p>
<p>So what would you miss if the CFPB suddenly disappeared?</p>
<p>In short, a lot, including a <a href="http://thehill.com/policy/finance/341313-consumer-bureau-releases-rule-to-prevent-banks-credit-card-firms-from-blocking">just-issued rule</a> that would prevent financial companies from using arbitration clauses to prevent people from having their day in court. </p>
<p>We base this conclusion on the work the three of us have done in recent decades. One of us (Sovern) has been writing about consumer law for more than 30 years, while the other two direct a <a href="http://www.stjohns.edu/law/consumer-justice-elderly-litigation-clinic">legal clinic that represents elderly consumers</a>. We’ve seen the worst of what financial companies can do, and we’ve also witnessed how the CFPB has begun to reverse the tide. </p>
<h2>Life before CFPB</h2>
<p>If you are one of the more than 29 million consumers who have collectively <a href="https://www.consumerfinance.gov/">received nearly US$12 billion</a> back from misbehaving financial institutions because of the CFPB’s efforts, you already know its value. But even if you are not, you have probably benefited from the bureau’s existence.</p>
<p>Before Congress created the bureau, there was no federal agency that made consumer financial protection its sole mission. Rather, consumer protection was rolled into the missions of a bunch of different agencies. And, as we saw during the financial crisis, regulators often gave it a back seat.</p>
<p>Congress, for example, gave the Federal Reserve the <a href="https://www.federalreserve.gov/reportforms/formsreview/RegZ_20080730_ffr.pdf">power to bar unfair and deceptive mortgage lending</a> in 1994. Yet the central bank considered consumer protection a backwater and didn’t use that power until 2008 – too late to prevent the <a href="https://theconversation.com/us/topics/great-recession-13707">Great Recession</a>. Congress took it away two years later when it passed Dodd-Frank.</p>
<p>The Office of the Comptroller of the Currency (OCC) regulates banks but was so preoccupied with ensuring lenders were safe that it failed to protect consumers from their predatory subprime mortgages – so much so that it prevented states from doing so too. And the Federal Trade Commission, which is tasked with fighting deceptive business practices, lacked the power to prevent such <a href="https://www.federalreservehistory.org/essays/subprime_mortgage_crisis">dangerous lending</a>.</p>
<p>This meant consumer protection on financial matters fell through the cracks. </p>
<p><a href="https://theconversation.com/how-wells-fargo-encouraged-employees-to-commit-fraud-66615">Wells Fargo’s recent fraud scandal</a> is a case in point. In the early 2000s, Wells Fargo employees <a href="https://www08.wellsfargomedia.com/assets/pdf/about/investor-relations/presentations/2017/board-report.pdf">began opening fake accounts</a> in clients’ names without permission, leading in some cases to <a href="https://www.wsj.com/articles/wells-fargo-is-trying-to-fix-its-rogue-account-scandal-one-grueling-case-at-a-time-1482855852?mg=prod/accounts-wsj%20rt5y7u6">lower credit scores</a> and a variety of fees. The bank <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2961347">ultimately opened millions of fraudulent bank and credit card accounts</a> before the scheme came to an end last year. </p>
<p>But as early as 2010, before the CFPB was set up, regulators at the OCC were increasingly aware of what was happening at Wells Fargo thanks to hundreds of <a href="https://theconversation.com/why-companies-like-wells-fargo-ignore-their-whistleblowers-at-their-peril-67501">whistleblower complaints</a>. The OCC even confronted the bank yet failed to take any action despite many red flags, according to an <a href="https://www.occ.gov/publications/publications-by-type/other-publications-reports/pub-wells-fargo-supervision-lessons-learned-41917.pdf">internal audit</a>. </p>
<p>It wasn’t until the <a href="http://freepdfhosting.com/29677883a9.pdf">Los Angeles city attorney</a> and the <a href="https://www.consumerfinance.gov/about-us/newsroom/consumer-financial-protection-bureau-fines-wells-fargo-100-million-widespread-illegal-practice-secretly-opening-unauthorized-accounts/">CFPB became involved</a> years later that Wells Fargo took forceful action to stop the fraud. The regulators <a href="https://www.consumerfinance.gov/about-us/newsroom/consumer-financial-protection-bureau-fines-wells-fargo-100-million-widespread-illegal-practice-secretly-opening-unauthorized-accounts/">fined Wells Fargo a total of $185 million</a> and forced it to refund fees it had charged customers and hire an independent consultant to review its procedures. </p>
<p>More importantly, they sent a clear message to other financial institutions: Cheat consumers and you will face the consequences.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/177626/original/file-20170710-5939-45mbev.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/177626/original/file-20170710-5939-45mbev.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=440&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/177626/original/file-20170710-5939-45mbev.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=440&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/177626/original/file-20170710-5939-45mbev.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=440&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/177626/original/file-20170710-5939-45mbev.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=553&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/177626/original/file-20170710-5939-45mbev.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=553&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/177626/original/file-20170710-5939-45mbev.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=553&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Consumer Financial Protection Bureau Director Richard Cordray testifies on Capitol Hill in 2013.</span>
<span class="attribution"><span class="source">AP Photo/Manuel Balce Ceneta</span></span>
</figcaption>
</figure>
<h2>Protecting consumers</h2>
<p>Since its inception, the bureau has acted repeatedly to stop financial institutions from harming consumers. </p>
<p>It blocked debt collector attorneys from <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-takes-action-halt-illegal-debt-collection-practices-lawsuit-mill-and-debt-buyer/">suing consumers based on false information</a>. It discovered systemic problems with consumer credit reports and forced companies to <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-oversight-uncovers-and-corrects-credit-reporting-problems/">correct errors</a>. It compelled credit card companies to <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-orders-subprime-credit-card-company-to-refund-2-7-million-for-charging-illegal-credit-card-fees/">refund illegal fees</a>. It protected borrowers from <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-sues-nations-largest-student-loan-company-navient-failing-borrowers-every-stage-repayment/">unlawful student loan servicing practices</a>. It <a href="https://www.consumerfinance.gov/about-us/blog/ally-to-repay-80-million-to-consumers-it-discriminated-against/">made lenders repay</a> consumers they discriminated against. It <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-recovers-more-than-1-million-for-servicemembers-veterans-and-their-families/">recovered money for veterans</a> who complained of abusive financial practices. </p>
<p>When the bureau began publishing <a href="https://www.consumerfinance.gov/data-research/consumer-complaints/">consumer complaints on its website</a>, companies that might previously have ignored negative feedback paid attention. Financial institutions have responded to complaints to the CFPB <a href="https://www.consumerfinance.gov/data-research/consumer-complaints/">more than 700,000 times</a>, often by providing a remedy to the consumers.</p>
<p>Besides protecting consumers, however, Congress had a second motive in creating the bureau: to help prevent the kind of mortgage lending that helped cause the Great Recession. </p>
<p>To that end, the bureau has adopted <a href="https://www.consumerfinance.gov/policy-compliance/rulemaking/final-rules/2013-integrated-mortgage-disclosure-rule-under-real-estate-settlement-procedures-act-regulation-x-and-truth-lending-act-regulation-z/">rules</a> that help consumers to understand their mortgages – something that often <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1531781">wasn’t possible</a> under the previously misleading mortgage disclosures. It also issued <a href="https://www.consumerfinance.gov/policy-compliance/rulemaking/final-rules/ability-repay-and-qualified-mortgage-standards-under-truth-lending-act-regulation-z/">regulations</a> to prevent consumers from taking out mortgages that they couldn’t repay. And after borrowers take out a mortgage, <a href="https://www.consumerfinance.gov/policy-compliance/rulemaking/final-rules/2013-real-estate-settlement-procedures-act-regulation-x-and-truth-lending-act-regulation-z-mortgage-servicing-final-rules/">CFPB servicing rules</a> establish the procedures servicers must follow when communicating with borrowers, correcting errors, providing information and dealing with loan modification requests.</p>
<p>Two of us have personal experience with one of the bureau’s new mortgage rules, which powerfully illustrates the value of the CFPB.</p>
<p>In 2014, Alice, a client of our law school clinic, was struggling to pay the mortgage on her home – which she had refinanced a few years earlier – after a stroke forced her into retirement. <a href="http://www.stjohns.edu/law/consumer-justice-elderly-litigation-clinic">Our clinic</a> helped her apply for a modification of her loan. </p>
<p>But within weeks, instead of acknowledging Alice’s application, the loan servicer summoned her to court to begin foreclosure proceedings in violation of <a href="https://www.law.cornell.edu/cfr/text/12/1024.41">CFPB servicing rules</a>. Fortunately, our clinic was able to rely on those rules in getting the foreclosure action dismissed. Alice got her loan modified and remains in her home. </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/177630/original/file-20170710-5982-qs3jpp.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/177630/original/file-20170710-5982-qs3jpp.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=482&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/177630/original/file-20170710-5982-qs3jpp.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=482&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/177630/original/file-20170710-5982-qs3jpp.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=482&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/177630/original/file-20170710-5982-qs3jpp.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=606&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/177630/original/file-20170710-5982-qs3jpp.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=606&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/177630/original/file-20170710-5982-qs3jpp.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=606&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Demonstrators tried to draw attention to the subprime mortgage crisis back in early 2008.</span>
<span class="attribution"><span class="source">AP Photo/Matt Rourke</span></span>
</figcaption>
</figure>
<h2>Protecting the vulnerable</h2>
<p>This reveals how the bureau is particularly important to protect vulnerable consumers, like the elderly, who are frequently targeted by fraudsters and predatory lenders because of their cognitive and other impairments and because they often have accumulated substantial assets. The CFPB is the only federal agency with an office <a href="https://www.consumerfinance.gov/educational-resources/resources-for-older-adults/">specifically dedicated</a> to protecting the financial well-being of older adults. </p>
<p>The bureau has brought cases against companies that attempted to take advantage of seniors by, for example, <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-and-new-york-department-of-financial-services-sue-pension-advance-companies-for-deceiving-consumers-about-loan-costs/">misrepresenting the interest rates</a> on pension advance loans or <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-takes-action-against-reverse-mortgage-companies-deceptive-advertising/">deceptive advertising</a>. In 2015 alone, consumer complaints to the CFPB brought relief to <a href="https://data.consumerfinance.gov/dataset/Consumer-Complaints/s6ew-h6mp">more than 600 older Americans just through debt collection problems</a>.</p>
<p>The bureau has also worked to prevent financial abuse of the elderly, estimated to cost seniors <a href="https://www.truelinkfinancial.com/research">as much as $36 billion annually</a>. The CFPB has educated <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-issues-advisory-and-report-for-financial-institutions-on-preventing-elder-financial-abuse/">financial institutions</a>, <a href="https://www.consumerfinance.gov/about-us/newsroom/cfpb-helps-assisted-living-and-nursing-facilities-protect-seniors-from-financial-abuse/">nursing facilities</a> and <a href="https://www.consumerfinance.gov/about-us/newsroom/director-cordray-remarks-on-money-smart-for-older-adults/">others</a> about recognizing and stopping elder financial abuse and exploitation.</p>
<h2>Consumer protection in peril</h2>
<p>Given Alice’s ill health, the consequences for her might have been disastrous if she had been thrown out of her home. But now she – and all of us – face the loss of the CFPB’s aid. </p>
<p>The CFPB <a href="http://www.latimes.com/business/la-fi-cfpb-cordray-hearing-20170405-story.html">is under attack</a> from Republican members of Congress who <a href="https://banks.house.gov/media/press-releases/banks-votes-choice-act-roll-back-dodd-frank-law">believe more in bank protection</a> than consumer protection. Some members have <a href="http://pubcit.typepad.com/clpblog/2017/02/ratcliffecruz-bill-would-eliminate-the-cfpb.html">proposed eliminating the agency altogether</a>. </p>
<p>The House of Representatives <a href="https://financialservices.house.gov/choice/">has passed a bill</a> that would cripple the CFPB by, for example, taking away the power it used to fine Wells Fargo for opening illegal accounts and concealing <a href="https://www.consumerfinance.gov/data-research/consumer-complaints/">its complaint database</a> from public view. In other words, it would force the bureau to sit idly by as financial institutions <a href="http://www.newsweek.com/your-bank-lying-you-619814">lie to consumers</a>. </p>
<p>Nearly every American has or will have a loan or bank account, a prepaid card, credit card, a credit report or some combination of those, and so has dealings with a financial institution policed by the CFPB. But <a href="http://press.princeton.edu/titles/10267.html">few of us read the fine print</a> governing these things or <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2516432">can understand it when we do</a>. That gives the companies that write these agreements the ability to draft them to suit their own interests at the expense of consumers. </p>
<p>Similarly, we do not always know when a financial institution takes advantage of us, just as Wells Fargo customers did not always know that it had opened unauthorized accounts that lowered their credit scores. </p>
<p>Consumers need protection from misbehaving companies. If the bureau is eliminated or significantly weakened, all consumers will suffer.</p><img src="https://counter.theconversation.com/content/80353/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Along with three co-authors, Jeff Sovern received a $29,510 grant from the American Association for Justice Robert L. Habush Endowment and by a grant from the St. John’s University School of Law Hugh L. Carey Center for Dispute Resolution in 2014 to study arbitration. It resulted in an article. Along with Professor Kate Walton, he received a grant from the National Conference of Bankruptcy Judges Endowment for Education to study debt collection, resulting in another article. He is a member of the National Association of Consumer Advocates. </span></em></p><p class="fine-print"><em><span>Ann L. Goldweber is affiliated with NACA as a member.</span></em></p><p class="fine-print"><em><span>Gina M. Calabrese is affiliated with the National Association of Consumer Advocates, New Yorkers for Responsible Lending, and the Association of the Bar of the City of New York (Chair, Committee on the Civil Court).</span></em></p>Republicans are hoping to eliminate or at least defang the only federal agency tasked solely with protecting consumers from financial abuses. What would we miss if they succeed?Jeff Sovern, Professor of Law, St. John's UniversityAnn L. Goldweber, Professor of Clinical Education, St. John's UniversityGina M. Calabrese, Professor of Clinical Education, St. John's UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/794792017-06-15T10:52:51Z2017-06-15T10:52:51ZAs Fed 'returns to normal,' is the risk of recession rising? Experts react<figure><img src="https://images.theconversation.com/files/173911/original/file-20170615-26091-1bokz3.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">Fed Chair Janet Yellen speaks at a press conference following the rate-hike decision.</span> <span class="attribution"><span class="source">AP Photo/Susan Walsh</span></span></figcaption></figure><p><em>Editor’s note: The Federal Reserve’s policy-setting committee <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614a.htm">raised its benchmark interest rate</a> by a quarter-point to a range of 1 to 1.25 percent, the second increase this year. The central bank also indicated that it will likely lift rates once more this year. Given that these developments weren’t exactly a shock, we asked a couple of Fed experts what was noteworthy about the announcement.</em></p>
<h2>What’s the real risk</h2>
<p><strong>Sheila Tschinkel, Emory University</strong></p>
<p>The Fed’s <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614a.htm">decision</a> to raise the <a href="https://fred.stlouisfed.org/series/FEDFUNDS">federal funds rate</a> was no surprise to financial markets. Nor was its expectation of one more hike this year. </p>
<p>Even though core inflation <a href="https://www.bls.gov/cpi/">has been below its 2 percent target</a>, the economy’s underlying strength suggests little or no risk of recession or deflation. </p>
<p>The Fed also said it is <a href="http://www.businessinsider.com/federal-reserve-rate-hike-plan-to-unwind-45-trillion-balance-sheet-2017-6">ready to begin reducing its holdings</a> of government and other securities later this year. As a result of “quantitative easing” – the purchase of mortgage-backed and government securities to reduce long-term borrowing costs – and other measures aimed at preventing a collapse of the financial system, the value of assets on its balance sheet <a href="https://www.federalreserve.gov/monetarypolicy/files/quarterly_balance_sheet_developments_report_201705.pdf">ballooned to US$4.47 trillion</a> from <a href="https://www.federalreserve.gov/boarddocs/rptcongress/annual07/sec6/c3.htm">$915 billion</a> at the end of 2007. </p>
<p>The Fed seems to believe the bigger risk, actually, is that the economy could overheat, particularly if ultra-low rates are combined with <a href="http://www.marketwatch.com/story/trumps-infrastructure-plan-could-be-a-powerful-economic-stimulus-2017-06-05">government stimulus</a> (which is still up in the air). The upshot is that the Fed seems pretty confident in the economic recovery and thinks it’s time to “begin the return to normal.” </p>
<p>Still, economic growth remains lower than many – including me – would like. It’s <a href="https://tradingeconomics.com/united-states/gdp-growth">ranged</a> from a disappointing 1 percent to 2 percent for the past few years. </p>
<p>The bigger risk facing the Fed might be that the economy is fundamentally not as strong the central bank believes it is. In that case, if the Fed continues to “normalize,” the economy could weaken and even go into recession.</p>
<p>Markets seem to reflect this view. <a href="http://www.macrotrends.net/2016/10-year-treasury-bond-rate-yield-chart">Yields on 10-year U.S. Treasuries</a>, for example, are actually lower than they were in November, even though the Fed has lifted its target interest rate by a quarter-point three times since then. This suggests investors are still anxious about the state of the U.S. and global economies – or something entirely different could be at work.</p>
<p>Without a crystal ball, we don’t know which view is right. While I can’t explain why bond yields have declined, I do believe the U.S. economy is doing all right and the Fed is on a reasonable path to normal.</p>
<h2>The Fed’s balance sheet quandary</h2>
<p><strong>William D. Lastrapes, University of Georgia</strong></p>
<p>Today’s announcement provides the first glimpse into how the Fed hopes to downsize a historically huge balance sheet. In other words, how does it plan to <a href="https://www.federalreserve.gov/monetarypolicy/files/quarterly_balance_sheet_developments_report_201705.pdf">reduce the $4.2 trillion in government bonds</a>, mortgage-backed securities and other assets it holds? </p>
<p>The Fed plans to take a <a href="http://www.businessinsider.com/federal-reserve-rate-hike-plan-to-unwind-45-trillion-balance-sheet-2017-6">gradual approach</a>. Essentially, the securities on the Fed’s balance sheet are continually maturing. As they do, the Fed has been taking the principal it collects and reinvesting it back in new securities. When the bank is ready to begin paring its holdings, it can simply stop reinvesting those proceeds, which will allow its balance to gradually decline. Or, if it would like to speed things up, it could sell some securities on the open market before they mature. </p>
<p>In other words, imagine your teenage self has seven $100 bills and you lend each to a friend in need on a different day of the week, starting on Monday, for a term of seven days. Come the following Monday, when the first bill is repaid, you decide to lend it out to someone else and continue to do so indefinitely. Essentially your balance sheet would always show $700 in assets. Then, if you decided to unwind your little bank, instead of relending the bills you began keeping them as they came due, thereby gradually reducing your assets until they hit zero. </p>
<p>There’s a flip side, however, as for every asset there needs to be a liability. And for every dollar drop in assets on the Fed’s balance sheet there needs to be a corollary decline in its liabilities. For your mini-bank, that liability might be the $700 you borrowed from your parents. And so when you stop relending those bills, you paid them back to your mom and dad, reducing what you owe. </p>
<p>The Fed borrows its money from banks in the form of “reserves” and so reduces these reserves when lending slows. And that’s where it finds itself in a serious quandary that could derail the economic recovery if not handled well. </p>
<p>Bank reserves – the safe and liquid cash assets that financial institutions hold as deposits at the Fed – <a href="https://www.federalreserve.gov/releases/h41/current/">currently total $2.2 trillion</a>, up from <a href="https://www.federalreserve.gov/releases/h41/20071227/">$5.8 billion in the last week of December 2007</a>. Almost all of these reserve holdings are excess reserves, which means they’re more than the Fed requires banks to hold in order to back up their deposits. </p>
<p>Why would banks keep so much of their portfolios in simple cash assets at the Fed and not in other securities or loans to businesses? One reason is that banks still desire safe and easily redeemable assets because of <a href="https://www.washingtonpost.com/news/wonk/wp/2017/04/21/trump-orders-another-review-of-post-financial-crisis-regulations-on-wall-street/">post-financial crisis regulations</a> and other lingering effects of the crisis. And what’s safer than the Fed, right? </p>
<p>An even bigger factor is that the Fed pays a relatively high yield on those excess reserves, now 1.25 percent, which exceeds what banks could get in comparably safe, short-term investments elsewhere. Why invest in anything else when parking that cash at the Fed is profitable and there is absolutely no default risk? </p>
<p>The problem for Chair Janet Yellen and her colleagues at the Fed is that if they try to pare back its balance sheet, banks may respond by cutting back on their own assets, such as loans to businesses and consumers, which in turn causes checking deposits and the money supply to drastically contract. The consequences are serious and include deflation and even recession. </p>
<p>So why not just reduce the rate it’s paying to the banks so that they don’t want to leave so much of their money at the Fed and instead lend it out? Increasingly, the Fed has been using interest rates on reserves as a way to help it set monetary policy and control its all-important federal funds rate. So if it lowers the interest rate on reserves, that’ll make hitting market interest rate targets that much more difficult.</p>
<p>The Fed now seems to get this and noted in its announcement that it plans to move cautiously on normalization while paying attention to the behavior of banks. The buildup of the Fed’s balance sheet during the financial was unprecedented. And now, so is policy normalization. Fed policymakers are correct to be cautious in their approach.</p><img src="https://counter.theconversation.com/content/79479/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Federal Reserve lifted rates for the second time this year and expects to do so once more, suggesting it's fairly confident the economic recovery will continue. Is it overconfident?Sheila Tschinkel, Visiting Faculty in Economics, Emory UniversityWilliam D. Lastrapes, Professor of Economics, University of GeorgiaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/774122017-05-12T12:07:31Z2017-05-12T12:07:31ZThe scandal might be over but LIBOR ethics remain fundamentally flawed<figure><img src="https://images.theconversation.com/files/169117/original/file-20170512-3664-16t9dx6.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">shutterstock.com</span></span></figcaption></figure><p>When I was a trader at HSBC, Citibank, Crédit Agricole and Merrill Lynch, being able to accurately predict the the <a href="https://www.theice.com/iba/libor">London Interbank Offered Rate (or LIBOR)</a> each day was a central part of my job. It was, and still is, the most important benchmark in finance – underpinning derivatives worth trillions of dollars. Predicting the number correctly was lucrative. Predicting it incorrectly could often be disastrous. </p>
<p>To guess the rate correctly, an endless list of things had to be taken into account. When would central banks change their interest rates? In what direction and by how much? What was already anticipated by the market? What could influence the central bankers’ decision going forward? The inflation rate, certainly. But a range of other factors also mattered: the unemployment rate, retail sales, household consumption, the exchange rate, etc. During crises, the ability of banks to borrow money also mattered, as well as how this ability (or inability) was judged to change in the future. </p>
<p>LIBOR was like a puzzle that never could be solved completely. Some days you might get very close, or even be spot on. But then, the next day arrived with a new box of jigsaw pieces and you had to start all over again. For me, it was one of the most intellectually stimulating parts of being a trader. </p>
<p>But it also became a daily source of irritation. This was especially the case if you were a trader not working for one of the banks involved in setting LIBOR (the benchmark is taken from the average rate that a panel of banks say they are willing to lend to each other), or not seated physically close to one of the traders responsible for inputting the numbers – both of which were true in my case. LIBOR sometimes appeared to be deliberately skewed in one direction or the other: high when I bet on it to be low or low when I bet on it to be high. </p>
<p>This got worse in the years building up to the financial crisis, as bank staff (<a href="https://www.zedbooks.net/shop/book/barometer-of-fear/forthcoming/">including myself</a>) increased their <a href="http://voxeu.org/article/excessive-risk-taking-banks-new-ereport">risk-taking activities</a> exponentially. The jigsaw puzzles got bigger and bigger– and the desire to solve them did too. The crisis itself did not act to reduce risk-taking behaviour. It did, however, turn my irritation with LIBOR into frustration. To me, LIBOR seemed to have become more and more incorrect.</p>
<p>When the financial crisis erupted, everything I did as a trader revolved around fear, or what the former chairman of the Federal Reserve, Alan Greenspan <a href="https://files.stlouisfed.org/files/htdocs/publications/es/09/ES0924.pdf">coined</a>: “the barometer of fears of bank insolvency”. He argued that LIBOR, when put in a specific context, was a kind of fear index related to banks. But I remember how surprised I was when talking to central bankers about LIBOR at the time, about the fear they were trying to fight. For different reasons, what’s <a href="https://www.theguardian.com/business/2017/jan/18/libor-scandal-the-bankers-who-fixed-the-worlds-most-important-number">been called</a> the “world’s most important number” had become extremely important to them and they, too, were desperately trying to solve the jigsaw puzzle – but often failed to understand exactly how it was calculated.</p>
<p>But what could be done? LIBOR was not regulated. Neither was it overseen by the central banks. Instead, the rules of the game were in the hands of a small handful of banks <a href="https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/191762/wheatley_review_libor_finalreport_280912.pdf">and a lobby working on their behalf</a>.</p>
<h2>Notes on a scandal</h2>
<p>The LIBOR scandal – the discovery that LIBOR had been systematically manipulated by banks – <a href="https://www.ft.com/content/e82cf02c-dd80-11e6-86ac-f253db7791c6">erupted in 2012</a>. Since then, efforts have been made to safeguard against manipulation and collusive practises in relation to setting the number. Banks have been fined billions for their involvement and tried to install better ethics into their organisational cultures, with terms such as <a href="https://www.fca.org.uk/news/speeches/conduct-risk-briefing">“conduct risk”</a> becoming a new buzzword. </p>
<p>The British Bankers Association, the bank lobby – which used to oversee the LIBOR fixing mechanism together with the banks themselves – is <a href="https://www.theguardian.com/business/2012/sep/25/bba-libor-setting-role-stripped-banks">no longer involved</a>. The process is now regulated by the Financial Conduct Authority and LIBOR manipulation has <a href="https://www.gov.uk/government/news/chancellor-confirms-manipulation-of-key-forex-benchmark-to-be-made-a-criminal-offense">become a criminal offence</a>. Steps have been taken to put things right.</p>
<p>But despite a <a href="https://www.theguardian.com/business/2013/apr/02/libor-regulations-rate-rigging-scandal">string of regulatory changes</a>, the puzzle continues to evoke irritation, frustration and fear – for different reasons. Traders are irritated by the army of compliance officers now occupying their dealing rooms, and “banker bashing” <a href="http://www.bbc.co.uk/news/business-22382932">has hardly diminished</a>. Members of the public are frustrated by the fact that no senior bankers have been held to account for the LIBOR scandal, let alone the financial crisis. Regulators are frustrated by <a href="http://blog.applied-corporate-governance.com/ethics/banking-culture-review-a-worthy-but-doomed-effort/">slow progress</a> towards an ethical banking culture. </p>
<p>Meanwhile, those that have been investigated, prosecuted, sentenced – or are waiting for that to happen to them – live in fear of ending up as fall guys for a <a href="https://theconversation.com/libor-one-man-found-guilty-but-culture-change-is-still-needed-in-financial-sector-45634">system or culture</a> in which they were actively participating and contributing to – <a href="http://www.telegraph.co.uk/finance/comment/kamal-ahmed/7891774/The-financial-crisis-blame-game-have-we-got-it-right-in-just-blaming-the-bankers.html">yet did not, themselves, create</a>.</p>
<p>Perhaps the question, then, is not so much whether the changes that have been introduced are sufficient to prevent future scandals, but whether LIBOR is a puzzle that is impossible to solve in and of itself.</p>
<p>The issue with LIBOR has always been ethics. Or the lack of them.</p>
<p>LIBOR manipulation was unethical, even though the process lacked regulation and legal precedents. It was unethical, regardless of whether it was widespread or maybe even encouraged by senior management. LIBOR manipulation was unethical, even if, as suggested by a <a href="http://www.bbc.co.uk/news/business-39548313">recent BBC Panorama investigation</a>, officials at the Bank of England knew about it. But then it was embedded in an unethical culture. </p>
<p>Perhaps we should ask ourselves a more difficult question: can betting on LIBOR, betting on the “barometer of fear” or betting on the health of the global financial system ever be considered ethical?</p><img src="https://counter.theconversation.com/content/77412/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alexis Stenfors is the author of Barometer of Fear: An Insider’s Account of Rogue Trading and the Greatest Banking Scandal in History.</span></em></p>LIBOR continues to evoke irritation, frustration and fear – for traders, central bankers and the public.Alexis Stenfors, Senior Lecturer in Economics and Finance, University of PortsmouthLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/734172017-05-03T01:14:23Z2017-05-03T01:14:23ZWhy Dodd-Frank – or its repeal – won't save us from the next crippling Wall Street crash<p>Republicans <a href="http://www.latimes.com/business/la-fi-dodd-frank-20170504-story.html">appear poised to roll back</a> Wall Street regulations passed after the 2008 financial crisis. Democrats <a href="http://www.cnbc.com/2017/02/07/if-trump-repeals-dodd-frank-it-would-be-a-monumental-mistake-bart-chilton-commentary.html">argue doing so</a> would be a “monumental mistake.” </p>
<p>It’s been framed as a typical fight over regulation. <a href="http://www.latimes.com/business/la-fi-dodd-frank-demoocrats-20170206-story.html">Democrats want more</a> to protect taxpayers and investors from the next crisis; Republicans want less because it <a href="https://www.nytimes.com/2017/02/03/business/dealbook/trump-congress-financial-regulations.html">stifles economic growth</a>. </p>
<p>So who’s right? </p>
<p>Based on our combined 35 years of experience with securities markets and the research we’ve done for our new book, “<a href="https://www.amazon.com/When-Levees-Break-Re-visioning-Regulation/dp/0739196049">When the Levees Break: Re-visioning Regulation of the Securities Markets</a>,” we think both sides are wrong. The issue isn’t about more or less regulation but about the need for a streamlined system that supports 21st-century investing. </p>
<p>If we had our way, the whole system of financial regulation would be burned to the ground and replaced with something entirely different. </p>
<h2>Of bonds and banks</h2>
<p>Before we go any further, let’s clarify what we’re talking about. When we think of financial markets, we tend to jumble securities markets like stocks, bonds and commodities with conventional bank lending such as checking accounts and lines of credit. </p>
<p>The <a href="http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm">Dodd-Frank Act</a>, for example, was ostensibly focused on regulation of securities markets, but the rules that got the most attention were those that affect the “too big to fail” banks. That those banks straddled both worlds made the market crash life-threatening. </p>
<p>But securities trading, and in particularly derivatives, were at the root of the 2008 financial crisis. For our purposes, when we talk about financial regulation, our focus is on the securities markets. </p>
<h2>How did we get here?</h2>
<p>The financial markets meltdown in the fall of 2008 devastated our economy, but it still <a href="http://online.wsj.com/mdc/public/page/2_3024-djia_alltime.html">pales in comparison</a> with the stock market rout that preceded the Great Depression in October 1929. The Dow Jones Industrial Average <a href="https://finance.yahoo.com/quote/%5EDJI/history?period1=475822800&amp;period2=1493697600&amp;interval=1d&amp;filter=history&amp;frequency=1d">fell</a> 23 percent from Oct. 28 to Oct. 29 that year, compared with a two-day slide of at most half that throughout the 2008 crisis. </p>
<p>After the 1929 crash, lawmakers reacted by passing laws aimed at ensuring investor protection. Two groundbreaking pieces of legislation, passed in 1933 and 1934, <a href="https://www.sec.gov/about/laws/sa33.pdf">required companies</a> to submit quarterly and annual reports and <a href="https://www.sec.gov/about/laws/sea34.pdf">established the Securities and Exchange Commission</a>. These laws form the cornerstone of modern securities markets regulation. </p>
<p>But they were only the beginning. As markets expanded and changed, Congress continued to craft new laws that added more agencies to oversee Wall Street activities. As a result, we have more than two dozen agencies, self-regulatory organizations and exchanges (including the <a href="https://www.cftc.gov">Commodities &amp; Futures Trading Commission</a>, the Treasury and the <a href="https://www.dol.gov/">Departments of Labor</a> and <a href="https://www.justice.gov">Justice</a>), not to mention state securities agencies, all with overlapping regulatory jurisdictions. </p>
<p>Moreover, the laws have been reactionary – rather than visionary – resulting in competing concerns and duplicative audit and enforcement procedures. Not surprisingly, there is largely no coordination or communication between them. </p>
<p>Meanwhile, the SEC – as primary regulator – is bogged down with too many directives, many of which are under- or unfunded. For decades, whenever Congress passed a bill to “regulate” big changes in the markets – from market crashes to “advancements” such as mutual funds and investment advisors – the SEC has been required to add oversight of these new practices to their existing responsibilities. Dodd-Frank, for example, expanded the SEC’s role and called for additional internal audits of existing practices but – like past market-related legislation – failed to include funding for those activities.</p>
<p>Amid all the regulation, investor protection seems to have gotten lost. </p>
<h2>Enter Dodd-Frank</h2>
<p>The severity of the 2008 crash and its economic impact (including investment company failures and unprecedented government bailouts) goaded Congress into action. </p>
<p>In 2010 Democratic lawmakers passed the <a href="https://www.sec.gov/about/laws/wallstreetreform-cpa.pdf">Dodd-Frank Act</a>, <a href="https://corpgov.law.harvard.edu/2010/11/20/the-financial-panic-of-2008-and-financial-regulatory-reform/">the most extensive revision of securities regulation</a> since the 1930s, with the hope that more regulation would prevent another crisis. </p>
<p>Republicans have argued for its repeal ever since, claiming <a href="http://financialservices.house.gov/dodd-frank/">the law</a> and the regulations designed to implement it (<a href="https://www.davispolk.com/Dodd-Frank-Rulemaking-Progress-Report/">many of which are behind schedule</a>) inhibit prosperity. </p>
<p>Both parties are missing the point. The current system of financial regulation is built on how stocks were traded in the 1930s – when computers and algorithmic trading had yet to be a glimmer in a <a href="https://www.merriam-webster.com/dictionary/quant">quant’s</a> eye. To paraphrase the <a href="https://www.youtube.com/watch?v=bAJ3-mbP1pY">Oldsmobile commercial</a>, it’s not your father’s stock market anymore.</p>
<h2>My, how markets have changed</h2>
<p>Financial markets have undergone a fundamental transformation over the past 80 years. </p>
<p>First of all, there are the investors themselves. The mom and pop investor that the SEC was created to protect has by and large been replaced by institutional investors, including quantitative analysts or <a href="http://www.nytimes.com/2010/02/21/business/21shelf.html">“quants”</a> that use complex algorithmic formulas to predict the best trading strategies. In fact, algorithmic trading makes up the <a href="https://www.wired.com/2010/12/ff_ai_flashtrading">majority</a> of volume in today’s markets.</p>
<p>Then there’s the issue of disclosure. Since the dawn of federal securities regulation, lawmakers and regulators have relied on <a href="http://heinonline.org/HOL/Page?handle=hein.journals/wvb118&amp;div=6&amp;g_sent=1&amp;collection=journals">disclosure</a> to protect investors. Public companies are required to disclose volumes of information, from <a href="https://www.sec.gov/news/pressrelease/2015-160.html">financial information</a> to dealings with <a href="https://www.sec.gov/divisions/corpfin/cfannouncements/itr-act2012.htm">Iran</a> and even their <a href="https://www.sec.gov/rules/final/33-8177.htm">Code of Ethics</a>. As a result, <a href="https://www.transactionadvisors.com/insights/considering-ipo-costs-going-and-being-public-may-surprise-you">a company can spend</a> <a href="https://www.quora.com/How-much-time-does-a-US-company-typically-spend-on-SEC-filing">over a million dollars each year</a> complying with disclosure regulations that few people actually read. Yet every time there’s a new disaster, Congress piles on the disclosure requirements, as happened with Dodd-Frank. </p>
<p>But for all the hundreds of pages of disclosure, at no time in the past 80 years has there been a mandate to review the actual securities products issued by public companies and investment banks. There are no “safety” standards for stocks, like there are for cars or toasters. The products that brought down the house in 2008 – mortgage-backed securities and products derived from them – continue to be offered to the public, including new ones backed by credit card debt and <a href="https://www.theatlantic.com/business/archive/2013/03/dont-panic-wall-sts-going-crazy-for-student-loans-but-this-is-no-bubble/273682/">student loans</a>.</p>
<p>Finally, the SEC and other regulators are unequipped to keep up with the breathtaking changes in technology, let alone anticipate potential advances and challenges. To understand why, one must only consider the breadth of organizations that have fallen victim to hackers, from <a href="https://www.bloomberg.com/news/articles/2014-03-13/target-missed-warnings-in-epic-hack-of-credit-card-data">Target</a> and <a href="https://www.nytimes.com/2017/03/15/technology/yahoo-hack-indictment.html?_r=0">Yahoo</a> to the <a href="http://www.politico.com/story/2013/06/computer-hacking-veterans-affairs-department-092227">Veterans Administration,</a> and the <a href="http://www.reuters.com/article/us-usa-fed-cyber-idUSKCN0YN4AM">Federal Reserve itself</a>.</p>
<p>Unfortunately, however, Congress <a href="https://cup.columbia.edu/book/how-they-got-away-with-it/9780231156912">does not fund the SEC</a> in a way that would allow it to pay for the skills or systems it needs to keep up with technological and other market advances. Following Dodd-Frank, for example, the SEC’s budget was actually reduced, even as its responsibilities multiplied.</p>
<p>In sum, what we have is a regulatory system that fails in its mission to protect investors. The structure used to oversee current investment practices, corporate disclosures, product development and technological advances is based on the market failures of 1929. It’s a bit like trying to surf the internet using a typewriter. </p>
<h2>Preparing for the next crash</h2>
<p>The next “big” crash will likely be bigger than the last one. So how do we prepare for it? </p>
<p>Dodd-Frank is largely an extension of the patchwork structure and won’t protect us in the future. Yet the Republican answer, to repeal it and let markets self-regulate, won’t stop the proliferation of products that nearly brought the house down in 2008. After the next crash, institutions will not be too big to fail, they’ll be too big to save.</p>
<p>The answer, in our view, is <a href="https://revisioninginvesting.com/">a complete rethinking of how we regulate investing</a>. As the White House moves to dismantle Dodd-Frank, this is the perfect time to do exactly that. Let’s get rid of what doesn’t work – which is pretty much everything – and replace it with a system that does. </p>
<p>What we envision is a contemporary, 21st-century holistic structure built on proactive, thoughtful and streamlined laws that takes into account markets that are technology-driven and move in nanoseconds. </p>
<p>Think of it this way: Our regulatory structure is like the dike that keeps springing leaks – the makeshift plugs we’ve used are so ineffective that the dike isn’t leaking – it’s crumbling. We need to build a new dike, using all available technology, before the next tidal wave hits. </p>
<p>We don’t claim to have all the answers. But we want to get the conversation started. We invite you to join in.</p><img src="https://counter.theconversation.com/content/73417/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Instead, we need to burn the entire system of financial regulation to the ground and replace it with something that supports investing the way it's done today.Jena Martin, Professor of Law, West Virginia UniversityKaren Kunz, Associate Professor of Public Administration, West Virginia UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/716752017-01-22T19:57:11Z2017-01-22T19:57:11ZTrump: how we got here<figure><img src="https://images.theconversation.com/files/153749/original/image-20170122-30995-1a3vpve.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">German stock market after US election, November 9, 2016.</span> <span class="attribution"><a class="source" href="http://www.epa.eu/politics-photos/markets-exchanges-elections-photos/stock-market-in-frankfurt-am-main-after-us-election-photos-53110735">Frank Rumpenhorst/EPA</a></span></figcaption></figure><p>It wasn’t supposed to happen like this.</p>
<p>As the American political scientist Francis Fukuyama told us more than 25 years ago in <a href="https://www.amazon.com/End-History-Last-Man/dp/0743284550"><em>The End of History and the Last Man</em></a>, the fall of the Berlin Wall and the collapse of the Communist bloc and the Soviet Union was going to usher in an eternal age of capitalist economics and liberal-democratic politics. Not all at once or everywhere. But the general direction of future political and economic trends was clear.</p>
<p>Much of what then happened in the subsequent decade seemed to confirm Fukuyama’s analysis. As capitalism advanced in the post-Communist countries and in parts of the ‘Third World’ that had long been protectionist, cross-border exchange expanded rapidly. This process was fostered by all manner of agreements to liberalize goods and services trade, notably by the creation in 1995 of the <a href="https://www.wto.org/english/thewto_e/whatis_e/who_we_are_e.htm">World Trade Organization</a> (WTO), which China joined in 2001. New or stronger regional organizations also buttressed this trend. The strongest of these, the European Union (EU) enlarged north- and eastwards and, as illustrated by the adoption of the euro and the creation of the borderless Schengen area, also became politically more integrated.</p>
<h2>1989: Liberal democracy as the ‘only game in town’</h2>
<p>Politically, liberal democracy looked set to become the ‘only game in town’. Large-scale armed conflicts became rarer and less bloody. Of course, former Yugoslavia collapsed violently, at the cost of some 140,000 human lives, but this was one of those regions still trapped in history, as Fukuyama wrote. Ditto parts of Africa. By the beginning of the new millennium, ex-Yugoslavia had been pacified and stabilized by liberal-Western military intervention and set on a path to join the EU like most other post-Communist European countries west of the former Soviet Union. </p>
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<figcaption><span class="caption">US president Ronald Reagan’s “Tear down this wall” speech at Berlin Wall, 12 June 1987.</span></figcaption>
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<p>Admittedly, this apparently powerful process of capitalist democratization encountered some very stubborn obstacles even at its peak. The suppression of the protest movement at Tiananmen Square crushed the possible seeds of political liberalization in China, where, while making a very successful transition to a capitalist economic system, the Communist Party maintained its monopoly of political power. </p>
<p>In Russia, the chaotic privatization of the economy that took place in an institutional and legal vacuum after the collapse of Communism created a new class of wealthy oligarchs, but did little to foster adherence to liberal-democratic values and free-market capitalism among Russians, many of whom felt humiliated by the loss of the Soviet ‘empire’ and rallied to the <a href="https://theconversation.com/russias-headlong-rush-into-populism-71101">nationalist agenda of Vladimir Putin</a>, all the more so, as, with rising natural resource prices, the Russian economy prospered under his leadership in the early 2000s. The Middle East was still dominated by repressive – either military or monarchical – political systems and – in as far as they did not benefit from plentiful natural resources – stagnant economies, fuelling the rise of radical Islamist politics.</p>
<h2>2003: History – and war – begin anew</h2>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/153709/original/image-20170121-30951-1c1m1cs.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img alt="" src="https://images.theconversation.com/files/153709/original/image-20170121-30951-1c1m1cs.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=237&amp;fit=clip" srcset="https://images.theconversation.com/files/153709/original/image-20170121-30951-1c1m1cs.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=458&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/153709/original/image-20170121-30951-1c1m1cs.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=458&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/153709/original/image-20170121-30951-1c1m1cs.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=458&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/153709/original/image-20170121-30951-1c1m1cs.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=575&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/153709/original/image-20170121-30951-1c1m1cs.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=575&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/153709/original/image-20170121-30951-1c1m1cs.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=575&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">President George W. Bush announces the beginning of ‘Operation Iraqi Freedom’, March 19, 2003.</span>
<span class="attribution"><a class="source" href="https://en.wikipedia.org/wiki/Iraq_and_weapons_of_mass_destruction#/media/File:Bush_announces_Operation_Iraqi_Freedom_2003.jpg">Paul Morse/Wikimedia</a></span>
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<p>Two events since the turn of the century undermined if not destroyed the process of capitalist democratization initiated by the end of the Cold War. The first was the US-led invasion and occupation of Iraq, a reaction to the 9/11 attacks and, indirectly, to the first Gulf War, after which, in opposition to US intervention in the region, Al Qaeda had been founded. </p>
<p>The fabrication of the ‘evidence’ to justify the invasion by the Bush administration de-legitimized the war and undermined support for future such interventions in the West. Democratic stability could not be engineered by external military force. The ascension of the Shiite community to power in Iraq sharpened the Shiite-Sunni conflict in the Middle East, pitting Iran and Saudi Arabia and their respective allies against each other, further de-stabilizing the entire region and culminating in the meanwhile <a href="https://theconversation.com/syrias-war-of-extermination-signals-the-end-of-the-international-community-66708">six-year-old bloody civil war in Syria</a>.</p>
<p>By far the largest number of Syrian war refugees remained either in the country or in neighbouring states. Enough – more than a million in 2015, including refugees or migrants from other countries – nonetheless made it to Europe to provide a huge boost in popular support for anti-immigrant, anti-Muslim and/or anti-EU parties in Europe.</p>
<h2>2008: Deregulation sparks a global financial crisis</h2>
<p>The second event – in 2008-2009 – was the Global Financial Crisis (GFC), the product in part of the comprehensive deregulation of the financial sector for which politically powerful, especially American, financial firms had very successfully lobbied in the preceding two decades. </p>
<p>Worldwide, post–Cold War trade liberalization had been a boon for a huge number of inhabitants in the former Communist and Third worlds – as well as for predominantly Western-owned multinational companies. Cross-national income disparities diminished. For inhabitants of the old democratic capitalist world, however, this process was a more mixed blessing. As consumers they benefited from the lower prices of goods produced more cheaply abroad. As employees, in any case confronted with labour-saving technological changes, they had to contend with the threat of lower wages and/or reduced job opportunities. The ‘hollowing-out’ of the middle classes gathered pace.</p>
<p>Post-Cold War, the distribution of income in the ‘old’ democratic capitalist world had thus already become more unequal – even before the GFC struck. Now, to forestall financial and economic collapse, governments in many countries had to spring in – very visibly – with taxpayers’ money to bail out financial firms, leading to exploding budget deficits and irresistible pressures to pursue fiscal austerity. From those who had relatively little was taken. To those who had caused the crisis and had a lot was given. </p>
<h2>2011: Popular protest from the left and right</h2>
<p>None of the heads of the firms that precipitated this crisis was subsequently pursued by the law, just as the regulatory changes introduced to avert a re-run of the crisis were for the most part modest. The widespread popular indignation at the crisis and how it was managed – most visibly expressed by such movements as ‘Occupy Wall Street’ and ‘We are the 99 per cent’ – was therefore perfectly comprehensible. Financial and political elites alike were increasingly discredited.</p>
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<a href="https://images.theconversation.com/files/153720/original/image-20170121-30951-h47b6h.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img alt="" src="https://images.theconversation.com/files/153720/original/image-20170121-30951-h47b6h.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/153720/original/image-20170121-30951-h47b6h.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=386&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/153720/original/image-20170121-30951-h47b6h.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=386&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/153720/original/image-20170121-30951-h47b6h.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=386&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/153720/original/image-20170121-30951-h47b6h.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=486&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/153720/original/image-20170121-30951-h47b6h.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=486&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/153720/original/image-20170121-30951-h47b6h.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=486&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Tea Party protesters in Washington DC, September 12, 2009.</span>
<span class="attribution"><a class="source" href="https://en.wikipedia.org/wiki/Tea_Party_movement#/media/File:9.12_tea_party_in_DC.jpg">NYyankees51/Wikimedia</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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<p>Discredited elites. Growing income inequality. Fiscal austerity. The threat – imagined or real – of large-scale immigration (with its associated fears of growing competition for jobs, wages and access to public services, let alone those concerning culture, religion and language). Increasingly numerous terrorist attacks. Add to these factors the perceived inability, even unwillingness of mainstream political parties of the Left and Right to confront and manage these issues effectively and you have the conditions for the perfect populist political storm that has hit the North Atlantic region in the last few years.</p>
<p>If anything the stage was better set for a populist takeover in many European countries than in the US. Under incessant German pressure for fiscal austerity, the Eurozone as a whole has struggled harder and longer to recover from the GFC than the US, where the Federal Reserve intervened much faster and more aggressively to rekindle economic growth. </p>
<p>The worst-hit Eurozone member, Greece, did actually fall to the radical Leftist Syriza. But, under the proportional-representation electoral systems in most European countries, populist movements elsewhere were unable to win governmental office, except – exceptionally – as junior partners in coalition governments where, as in Finland, their influence has hitherto been contained and their support has receded. </p>
<p>In contrast, the US political process – with primary elections to choose party candidates and first-past-the-post elections for public office – was more vulnerable to conquest by a populist candidate.</p>
<h2>2016: A billionaire shall lead them</h2>
<p>Enter Trump, who could run on the ticket of one of the two dominant American political parties and inherit the loyalty to the Republican Party of a large proportion of American voters. A multi-billionaire real estate magnate might seem to be an improbable tribune of Americans on ‘main street’. Trump nonetheless succeeded in re-awakening historically deeply-rooted isolationist and protectionist sentiments in the US and mobilizing all the fears relating to globalization, immigration and terrorism – the economic, social, cultural and physical insecurity – that had waxed over the preceding two decades.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/153712/original/image-20170121-30951-11n793n.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img alt="" src="https://images.theconversation.com/files/153712/original/image-20170121-30951-11n793n.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/153712/original/image-20170121-30951-11n793n.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=450&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/153712/original/image-20170121-30951-11n793n.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=450&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/153712/original/image-20170121-30951-11n793n.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=450&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/153712/original/image-20170121-30951-11n793n.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=566&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/153712/original/image-20170121-30951-11n793n.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=566&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/153712/original/image-20170121-30951-11n793n.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=566&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Trump Taj Mahal Casino. Inaugurated in 1990, it would go through several bankruptcies and definitively close in 2016.</span>
<span class="attribution"><a class="source" href="https://fr.wikipedia.org/wiki/Donald_Trump#/media/File:Trump_Taj_Mahal,_2007.jpg">Kevin Wong/Wikimedia</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span>
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<p>The populist counter-revolution may now begin. It will not be pleasant. Its effects will be felt far beyond the United States. From the United Nations and NAFTA to NATO and the EU, many of the international institutions that have facilitated peaceful international cooperation and exchange – will be in Trump’s line of fire. International politics are likely to become more anarchic, conflictual and violent.</p>
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<p><em>Continue reading with <a href="http://theconversation.com/trump-where-we-might-end-up-71674">‘Trump: Where We Might End Up’</a>.</em></p><img src="https://counter.theconversation.com/content/71675/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Douglas Webber does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The fall of the Berlin wall was supposed to usher in ‘the end of history’, an eternal age of capitalist economics and liberal-democratic politics. It hasn’t turned out that way.Douglas Webber, Robert Schuman fellow, European University Institute, and Professor of Political Science, INSEADLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/675012016-10-24T04:09:26Z2016-10-24T04:09:26ZWhy companies like Wells Fargo ignore their whistleblowers – at their peril<p><a href="http://www.nbcnews.com/id/11839694/ns/business-corporate_scandals/t/enron-whistleblower-tells-crooked-company/#.WA1Xktzrr_Q">Enron</a>. <a href="http://usatoday30.usatoday.com/money/companies/regulation/2008-02-14-cynthia-cooper-whistleblower_N.htm">Worldcom</a>. The <a href="http://content.time.com/time/business/article/0,8599,1877181,00.html">Madoff scandal</a>. The <a href="http://www.rollingstone.com/politics/news/the-9-billion-witness-20141106">mortgage meltdown</a>. Now <a href="http://www.nytimes.com/2016/10/12/business/dealbook/at-wells-fargo-complaints-about-fraudulent-accounts-since-2005.html?_r=0">Wells Fargo</a>. </p>
<p>High-profile corporate frauds like these all seem to follow the same pattern. First the misconduct is discovered, and then we learn about all of the whistleblowers who tried to stop the fraud much earlier. Congress then tries to enhance whistleblower protections, with varying success. </p>
<p>The <a href="http://www.soxlaw.com">Sarbanes-Oxley Act</a>, passed in 2002 after the Enron and Worlcom scandals, <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2064061">was supposed to protect whistleblowers</a> who uncovered accounting frauds, but judges <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2064061">typically rejected</a> their retaliation claims. The <a href="https://www.whitehouse.gov/economy/middle-class/dodd-frank-wall-street-reform">Dodd Frank Act</a>, approved in 2010, <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2020527">provides financial rewards</a> for certain whistleblowers. Its success is still unclear.</p>
<p>While these laws may protect employees who expose wrongdoing from retaliation and encourage more to do the same, <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=930226">nothing requires employers</a> to take their disclosures seriously. And as we saw with the latest scandal involving Wells Fargo, several former employees say they tried to get the company’s attention <a href="http://www.nytimes.com/2016/10/12/business/dealbook/at-wells-fargo-complaints-about-fraudulent-accounts-since-2005.html?_r=0">in 2005</a> and <a href="https://news.vice.com/story/wells-fargo-bank-scandal?cl=fp">2006</a>, to no avail. </p>
<p>Their ineffectiveness is hardly unique. The <a href="https://berkleycenter.georgetown.edu/publications/2011-national-business-ethics-survey-workplace-ethics-in-transition">2011 National Business Ethics Survey</a> found that 40 percent of employees who reported misconduct believed that their report had not been investigated. When an investigation did take place, over half thought the process was unfair.</p>
<p>So why don’t companies make better use of the information they get from their whistleblowers – especially when ignoring them could expose their company to millions or even <a href="https://www.justice.gov/opa/pr/glaxosmithkline-plead-guilty-and-pay-3-billion-resolve-fraud-allegations-and-failure-report">billions</a> in liability and permanently tarnish their brand?</p>
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<figcaption><span class="caption">Socially awkward whistleblowing in ‘The Big Short.’</span></figcaption>
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<h2>Who looks the part</h2>
<p>For a start, real whistleblowers don’t always match our mental image. </p>
<p>Our idealized image of whistleblowers isn’t doing us any favors. We assume that whistleblowing will come from top employees. But when the company already has a poor ethics culture, those top employees may very well be the ones engaged in the misconduct. </p>
<p>Instead, as I described in a previous <a href="https://papers.ssrn.com/sol3/papers.cfm?abstract_id=930226">research paper</a>, important information might originate from employees who don’t fit in or are labeled as complainers or poor performers. </p>
<p>In other words, we expect the true whistleblower to be Ryan Gosling’s suave character in “The Big Short,” while ignoring the angry insights from Steve Carrell, on account of his bad haircut and terrible social skills.</p>
<p>To take whistleblowers seriously, we need to set aside our judgments about them and their motives and focus instead on the message they convey. In the words of negotiation gurus Roger Fisher and Bill Ury, “<a href="https://books.google.com/books?id=SgONZTjbqpgC&amp;dq=%22getting+to+yes%22&amp;hl=en&amp;sa=X&amp;ved=0ahUKEwjft_uD0ufPAhVJ5WMKHWKiAk8Q6AEIOjAC">separate the people from the problem</a>.”</p>
<h2>Where there’s smoke, is there fire?</h2>
<p>A second problem with whistleblowing is that we tend to assume it’s not an emergency if other people don’t think so. </p>
<p>There is a principle in social psychology known as the “<a href="http://psycnet.apa.org/journals/bul/137/4/517/">bystander effect</a>,” which essentially means that people defer to others on how to interpret ambiguous situations and dread the idea of overreacting to a situation and later being embarrassed. It also means that when you observe others doing nothing in response to an apparent risk, you’re more likely to do the same. </p>
<p>In a <a href="http://psycnet.apa.org/journals/psp/10/3/215/">famous experiment</a>, researchers observed how people reacted to a room filling with smoke, contrasting the behavior of those who were alone to those accompanied by others who were instructed in advance to appear indifferent to the smoke. Of those who were alone, 75 percent reported the smoke to the experimenter. By contrast, only 10 percent of the subjects sitting with the passive seatmates reported the smoke.</p>
<p>The same may be true of whistleblowing. The fact that “everyone knows” about a particular type of misconduct may actually make people less likely to report it. In addition, when a particular type of misconduct becomes prevalent, those investigating may discount the severity of conduct they see frequently and thereby fail to realize that it has reached a crisis level.</p>
<h2>How whistleblowing is like an iceberg</h2>
<p>Another problem is that whistleblowers may not know which information is most important. </p>
<figure class="align-right zoomable">
<a href="https://images.theconversation.com/files/142807/original/image-20161023-15950-509mx9.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img alt="" src="https://images.theconversation.com/files/142807/original/image-20161023-15950-509mx9.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=237&amp;fit=clip" srcset="https://images.theconversation.com/files/142807/original/image-20161023-15950-509mx9.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=508&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/142807/original/image-20161023-15950-509mx9.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=508&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/142807/original/image-20161023-15950-509mx9.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=508&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/142807/original/image-20161023-15950-509mx9.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=639&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/142807/original/image-20161023-15950-509mx9.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=639&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/142807/original/image-20161023-15950-509mx9.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=639&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Good investigators dig below the surface of a complaint.</span>
<span class="attribution"><span class="source">ABA Corporate Compliance Officer Deskbook (forthcoming)</span>, <span class="license">Author provided</span></span>
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<p>Whistleblowers, especially those uncovering substantial misconduct, have only one piece of what might be a much larger puzzle. They also aren’t lawyers, so they don’t know whether a piece of information is legally important. They only know that the situation feels wrong. Consequently, the important nugget of information might be buried within a lot of irrelevant information.</p>
<p>The <a href="https://news.vice.com/story/wells-fargo-bank-scandal?cl=fp">2006 letter</a> from a Wells Fargo whistleblower – who disclosed that other employees were opening fake accounts – is a good example of this problem. The first page of the letter contains generic complaints about unfair treatment and possibly age discrimination. The second page then talks about how salespeople “gamed” the system to inflate their sales numbers – but apparently with the assistance and consent of the customer involved. Sandwiched between these (somewhat) benign accusations is a story about how a customer complained that accounts were opened without his knowledge or consent.</p>
<p>Wells Fargo apparently ignored the report, to its peril and the detriment of millions of customers. The person reading the letter may have started out feeling suspicious of the whistleblower, confirmed that suspicion based on the first page of the letter and then completely missed the important information on the second page. Like <a href="https://commons.wikimedia.org/wiki/File:Duck-Rabbit_illusion.jpg">this illusion</a>, once the reader forms an initial impression (e.g., that the image features a duck), they became blind to additional data that contradicts the impression (the image could also be a rabbit). </p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/142804/original/image-20161023-15944-kx09wb.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/142804/original/image-20161023-15944-kx09wb.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=306&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/142804/original/image-20161023-15944-kx09wb.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=306&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/142804/original/image-20161023-15944-kx09wb.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=306&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/142804/original/image-20161023-15944-kx09wb.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=384&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/142804/original/image-20161023-15944-kx09wb.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=384&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/142804/original/image-20161023-15944-kx09wb.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=384&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Is it a duck? Or a rabbit?</span>
<span class="attribution"><a class="source" href="https://commons.wikimedia.org/wiki/File:Duck-Rabbit_illusion.jpg">J. Jastrow (1899) via Wikimedia Commons</a></span>
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</figure>
<p>The idea that we “see what we want to see” is not mere conjecture. <a href="http://psycnet.apa.org/journals/psp/91/4/612/">One study</a> found that people literally saw what they wanted to see in a drawing, perceiving an ambiguous drawing as a “B” or the number “13” depending upon which interpretation led to a more favorable result for themselves in the experiment. </p>
<h2>Challenges investigating complaints</h2>
<p>And a final problem: Explosive complaints are as rare as explosive luggage. </p>
<p>Publicly traded companies like Wells Fargo are required under <a href="https://www.google.com/url?sa=t&amp;rct=j&amp;q=&amp;esrc=s&amp;source=web&amp;cd=3&amp;ved=0ahUKEwiyp76i6-fPAhUFx2MKHfakAr0QFggrMAI&amp;url=https%3A%2F%2Fwww.sec.gov%2Fabout%2Flaws%2Fsoa2002.pdf&amp;usg=AFQjCNG1R7ILxKpeO0FzcC-5beXMyCsz9A">Sarbanes-Oxley</a> to have a process for receiving and responding to anonymous whistleblower complaints. Wells Fargo, like many other companies, had a whistleblower hotline. Why didn’t those folks – whose job it was to investigate complaints – uncover the misconduct early enough to stop it?</p>
<p>Investigating corporate complaints is a lot like being a Transportation Security Administration agent. Most of the complaints they are sorting through will be regular luggage, with a few unauthorized bottles of liquid here and there. Take the problem of reading that 2006 letter and multiply it by 100 or 1,000 letters, almost all of which describe an isolated problem or conduct that isn’t illegal. You don’t get much practice at the most important part of your job (identifying explosives) when it virtually never happens.</p>
<p>Like TSA agents, investigators also have the challenge of identifying a new form of misconduct that doesn’t match the mental models of prior bad acts. In other words, Wells Fargo may have been most worried about mortgage fraud when they should have spent more time investigating fraud in retail banking.</p>
<p>Great investigators are like the guys from the History Channel’s “American Pickers” show. They meet the owners, listen to their story, go through the stuff themselves and then make judgments about what to pursue based on their independent judgment and experience. They’re also open to finding the “best” stuff in unexpected places. </p>
<p>Lastly, great investigators keep an eye out for patterns, noticing when seemingly isolated incidents may indicate a larger problem.</p>
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<figcaption><span class="caption">American Pickers illustrate how to be a skilled investigator.</span></figcaption>
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<h2>An invaluable asset</h2>
<p>Managers and corporate officers responding to complaints need to shed their preconceptions about whistleblowers and instead invest in the information they receive. </p>
<p>Rather than grumbling about the cost of dealing with them, companies should view their information as a valuable corporate asset. Preventative investments like training managers on responding to whistleblowers, maintaining a hotline and hiring investigators and compliance officers to follow their leads ultimately serve a company’s long-term interests.</p>
<p>If the Wells Fargo scandal proves anything, it is that a 164-year-old brand can be tarnished overnight. A whistleblower – however flawed she may be – may be the last person standing between a company and the loss of its reputation.</p><img src="https://counter.theconversation.com/content/67501/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Elizabeth C. Tippett does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The bank's recent scandal probably would never have happened had senior management only listened to Wells Fargo's whistleblowers.Elizabeth C. Tippett, Assistant Professor, School of Law, University of OregonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/661062016-09-29T00:46:20Z2016-09-29T00:46:20ZThe U.S. economy is in desperate need of a strong dose of fiscal penicillin<figure><img src="https://images.theconversation.com/files/139651/original/image-20160928-27054-17016pi.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">The U.S. could do with a shot in the arm too.</span> <span class="attribution"><span class="source">Bear syringe via www.shutterstock.com</span></span></figcaption></figure><p>Despite six years of “recovery” from the Great Recession, America’s middle class still struggles financially amid sluggish economic growth and middling job creation. </p>
<p>The <a href="https://theconversation.com/us/topics/fomc-12831">Federal Reserve’s near-zero interest rates</a> have helped stabilize the economy after it nearly went into freefall in 2008 and 2009, but that policy is coming to an end, with at least one quarter-point hike expected this year and more in 2017 and 2018. </p>
<p>So what will support the economy once the Fed’s largesse begins to disappear? </p>
<p>I’ve been exploring the key economic data – from productivity and housing to wage growth and consumer spending – to better understand where we’re headed and what is needed to get out of this no-to-low growth environment, a pernicious state some economists call <a href="http://larrysummers.com/category/secular-stagnation/">secular stagnation</a>. The data show clearly why serious attention is needed to foster faster growth, a more competitive economy and more opportunities for American families. </p>
<p>And only one institution, I would argue, is able to do something about it: Congress. </p>
<h2>Stagnant growth and productivity</h2>
<p>For most of the recovery, economic growth has been lackluster. </p>
<p><a href="http://www.bea.gov/iTable/index_nipa.cfm">Gross domestic product has expanded</a> at an average annual inflation-adjusted rate of just 2 percent since the <a href="http://www.nber.org/cycles.html">recession</a> ended in the second quarter of 2009, far below the rate of 3.4 percent from December 1948, when the first recession after World War II started, to December 2007, when the most recent recession began. And in just the past three quarters through June, the economy has barely budged, growing at an <a href="http://www.bea.gov/iTable/iTableHtml.cfm?reqid=9&amp;step=3&amp;isuri=1&amp;903=1">anemic 1 percent or so</a>. </p>
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<p>Productivity growth, measured as the increase in inflation-adjusted output per hour, is key to propelling strong economic growth because it means that workers are getting better at doing more in the same amount of time. Yet <a href="http://data.bls.gov/pdq/querytool.jsp?survey=pr">productivity</a> rose only a total of 6.6 percent from the second quarter of 2009 to the second quarter of 2016. That amounts to an average rate of 0.9 percent a year, a fraction of the 2.3 percent we experienced from 1948 to 2007. </p>
<h2>Housing hasn’t recovered</h2>
<p>When considering what’s keeping the recovery from taking off, housing deserves particular attention since it <a href="https://books.google.com/books?id=MplpAgAAQBAJ&amp;printsec=frontcover&amp;dq=epstein+wolfson+handbook+of+political+economy+of+financial+crisis+oxford&amp;hl=en&amp;sa=X&amp;ved=0ahUKEwjr3areorDPAhXELB4KHcKfA3gQ6AEIHDAA#v=onepage&amp;q=epstein%20wolfson%20handbook%20of%20political%20economy%20of%20financial%20crisis%20oxford&amp;f=false">generally boosts economic growth</a> after a recession. Not this time.</p>
<p>Sales of new single-family homes have been on the rise in recent years, but they’re still well below the historical average before the Great Recession, pushing homeownership down to a 50-year low. Sales averaged about 400,000 a year from 2011 to 2015, compared with 698,000 before the recession – from 1963 through 2007.</p>
<p>Although the pace has picked up in recent months – reaching an annual rate of <a href="https://www.census.gov/construction/nrs/pdf/newressales.pdf">609,000</a> in August – it’s still not enough to stop the slide in the homeownership rate, which was <a href="http://www.census.gov/housing/hvs/files/qtr216/tab5.xlsx">62.9 percent</a> in the second quarter, down from <a href="http://www.census.gov/housing/hvs/files/qtr216/tab5.xlsx">67.8 percent</a> at the end of 2007.</p>
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<p>And spending on housing fell <a href="http://www.bea.gov/iTable/iTable.cfm?reqid=9&amp;step=3&amp;isuri=1&amp;903=141#reqid=9&amp;step=3&amp;isuri=1&amp;903=141">7.7 percent</a> in the second quarter of 2016, compared with the first three months of the year.</p>
<p>One of the reasons housing has been slow to recover – the market’s collapse was the primary cause of the Great Recession – is that employment growth has remained mostly moderate. Many are still looking for good jobs despite the sharp drop in headline unemployment to an <a href="http://data.bls.gov/pdq/querytool.jsp?survey=ln">eight-year low of 4.9 percent</a>.</p>
<p>The average annualized employment growth rate from June 2009 to August 2016 was just 1.4 percent, well below the long-run average of 1.9 percent from December 1948 to December 2007.</p>
<p>While there were <a href="http://data.bls.gov/pdq/querytool.jsp?survey=ce">13.6 million more jobs in August</a> than in June 2009 – meaning that the economy regained all those lost during and immediately after the recession – these gains and the comparatively low unemployment rate obscure that many people still cannot find the jobs they want. The jobless rate means about 7.8 million individuals were unemployed in August, yet <a href="http://www.bls.gov/news.release/pdf/empsit.pdf">another 7.8 million</a> were either employed part time for economic reasons (they would have preferred a full-time job) or out of work and wanted a job but weren’t counted in the official rate because they hand’t looked in the preceding four weeks.</p>
<p>And communities of color <a href="http://www.bls.gov/news.release/pdf/empsit.pdf">still have higher unemployment rates</a> than whites. The African-American unemployment rate stood at 8.1 percent, while for Hispanics it was 5.6 percent, compared with 4.4 percent for whites. </p>
<h2>Wage growth, income inequality and debt</h2>
<p>These lackluster job gains have meant there’s less pressure on employers to raise wages. And sluggish wage growth has meant less consumer spending – which typically makes up <a href="https://www.stlouisfed.org/publications/regional-economist/january-2012/dont-expect-consumer-spending-to-be-the-engine-of-economic-growth-it-once-was">more than two-thirds of GDP</a>.</p>
<p>Wages, in fact, have barely kept pace with price increases. <a href="http://data.bls.gov/pdq/querytool.jsp?survey=ce">Inflation-adjusted hourly earnings of production and non-supervisory workers</a> – about 80 percent of the labor force – have increased only about 4.5 percent since June 2009. This amounts to an annualized growth rate of merely 0.6 percent above the rate of inflation over the past seven years. </p>
<p>Low wage growth has kept income inequality at very high levels. A recent report offered some good news: Real median household income grew at <a href="http://www.census.gov/newsroom/press-releases/2016/cb16-158.html">5.2 percent,</a> from US$53,718 in 2014 to $56,516 in 2015 – the <a href="https://www.whitehouse.gov/blog/2016/09/13/income-poverty-and-health-insurance-united-states-2015">fastest annual growth on record dating back to 1968</a>. But inflation-adjusted <a href="http://www.census.gov/newsroom/press-releases/2016/cb16-158.html">median income was still higher in 2007</a> than in 2015.</p>
<p>Middle-class Americans are only slowly gaining ground as wealthier ones had seen bigger gains, leaving <a href="https://theconversation.com/us/topics/economic-inequality-15917">income inequality</a> persistently high. In 2015, the <a href="http://www2.census.gov/programs-surveys/demo/tables/p60/256/table4.xls">top 5 percent</a> of earners captured 22.1 percent of total income, compared with 11.3 percent for the bottom 40 percent. In 1967, those at the top took home 17.2 percent, versus 14.8 percent for the bottom 40 percent.</p>
<p>This lack of wage growth also makes it difficult for households to dig out from under a mountain of debt, which further contributes to limited spending on housing and other items. <a href="http://www.federalreserve.gov/releases/z1/current/z1.pdf">Household debt equaled 105.2 percent of after-tax income in the second quarter of 2016</a>. While that’s down from a peak of 135 percent in the fourth quarter of 2007, the current level is still much higher than any level of debt observed in the 50 years before 2002. </p>
<p>Moreover, some especially costly forms of credit have grown. Installment debts – mainly student and car loans – have grown from 14.6 percent of after-tax income in June 2009 <a href="http://www.federalreserve.gov/releases/z1/current/z1.pdf">to 19.2 percent this past June</a> – the highest share since records began in 1968.</p>
<p>Unsurprisingly, consumer spending growth has been middling as a result, increasing an average of just 2.3 percent a year since the end of the Great Recession, far below the long-term average of 3.5 percent from 1948 through 2007. </p>
<h2>Companies on the sidelines</h2>
<p>With their consumers still mired in debt with little gain in their pocketbooks, businesses have very few reasons to invest. </p>
<p>Net investment – what companies spend on new capital assets rather than on replacing obsolete items – has averaged 1.9 percent of GDP since the recession started at the end of 2007. This is the lowest since World War II. </p>
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<p>To be clear, companies have the money. <a href="http://www.federalreserve.gov/releases/z1/current/default.htm">Corporate profits</a> recovered quickly toward the end of the Great Recession and have stayed high since.</p>
<p>So where is all that money going? Cash reserves and shareholders. </p>
<p>Nonfinancial corporations hold an average of <a href="http://www.federalreserve.gov/releases/z1/current/default.htm">5.2 percent of all of their assets in cash</a> – a high rate by historical standards. At the same time, they spent on average <a href="http://www.federalreserve.gov/releases/z1/current/default.htm">99 percent of their after-tax profits on dividend payouts and share repurchases</a> to keep their shareholders happy since the start of the Great Recession.</p>
<h2>Breathing room</h2>
<p>With consumers not spending money because they can’t and businesses not spending money because they don’t want to, the onus falls on Congress to bolster the economy and the labor market. </p>
<p>Yet <a href="http://www.bea.gov/iTable/iTableHtml.cfm?reqid=9&amp;step=3&amp;isuri=1&amp;903=94">federal</a>, <a href="http://www.bea.gov/iTable/iTableHtml.cfm?reqid=9&amp;step=3&amp;isuri=1&amp;903=94">state and local</a> government spending has been falling. Their total spending on goods and services as a share of GDP was 17.7 percent in the second quarter of 2016, the smallest share since 1998. </p>
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<p>Congress, though, now has room to maneuver. The nonpartisan Congressional Budget Office estimated in August that the federal government will have a deficit of <a href="https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/51908-2016_Outlook_Update-2.pdf">3.2 percent of GDP</a> for fiscal year 2016. This is much smaller than in recent years, including 2009’s deficit of <a href="https://www.cbo.gov/publication/50974">9.8 percent of GDP</a> – the widest since World War II. </p>
<p>The shrinking deficit, as well as the government’s near-record-low borrowing costs, could provide enough breathing room to focus on targeted, efficient policies that promote long-term economic growth and shared prosperity, for instance, through <a href="https://www.americanprogress.org/issues/economy/report/2016/07/14/141157/an-infrastructure-plan-for-america/">investments in infrastructure</a>. </p>
<p>The economy and American families need Congress to use this breathing room to create real economic security.</p><img src="https://counter.theconversation.com/content/66106/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Christian Weller is a senior fellow at the Center for American Progress. </span></em></p>Although the Fed delayed raising rates this month, it has signaled it intends to wean the U.S. economy off its unprecedented monetary stimulus. Now the question is whether Congress will take the handoff.Christian Weller, Professor of Public Policy and Public Affairs, University of Massachusetts BostonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/656312016-09-19T01:22:57Z2016-09-19T01:22:57ZShould Wells Fargo execs responsible for bilking customers be forced to return their pay?<figure><img src="https://images.theconversation.com/files/138136/original/image-20160918-17018-15hcbki.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=496&amp;fit=clip" /><figcaption><span class="caption">In Wells Fargo&#39;s case, a discussion often wasn&#39;t required. </span> <span class="attribution"><span class="source">Wells Fargo via www.shutterstock.com</span></span></figcaption></figure><p>Having spent five years supervising large financial institutions on Wall Street, I am rarely surprised by the latest news of banks behaving badly. </p>
<p>But even the most hardened cynics, such as myself, were taken aback by the <a href="http://www.wsj.com/articles/wells-fargo-to-pay-185-million-fine-over-account-openings-1473352548">recent announcement</a> that Wells Fargo was being fined US$185 million for fraudulent sales practices that included opening over two million fake deposit and credit card accounts without informing its customers. </p>
<p>Adding to my shock was the revelation that the firm fired 5,300 employees over the course of five years for engaging in this behavior, clearly evidence that this was more than just a few bad apples.</p>
<p>The financial crisis and its aftermath have taught us that it is unlikely any of Wells Fargo’s senior executives will face criminal charges. The <a href="https://www.amazon.com/Capital-Offenses-Business-Punishment-Corporate/dp/039324783X">reasons for this are numerous</a>, but essentially prosecutors have a hard time identifying criminal intent within the upper ranks of bank management.</p>
<p>At the very least, don’t Wells Fargo’s customers have a reasonable expectation that executives who profited off their misfortune be required to return some of their ill-gotten gains?</p>
<p>The good news is that in April, U.S. regulators released a <a href="https://www.gpo.gov/fdsys/pkg/FR-2016-06-10/pdf/2016-11788.pdf">proposed rule</a> requiring financial institutions to do just that. Unfortunately for fraud victims seeking a pound of flesh from Wells Fargo executives, the rule is not scheduled to be finalized until November, although the bank claims to be in adherence with the proposal’s main provisions. </p>
<p>Nonetheless, I thought it would be interesting to examine the text of the proposed incentive-based compensation rule through the lens of the Wells Fargo situation to try and understand its potential implications.</p>
<h2>Cultural failure</h2>
<p>On the surface Wells Fargo’s fraud appears to be an all-too-familiar case of cultural failure within a big financial institution. Apparently CEO John Stumpf disagrees. </p>
<p>In a <a href="http://www.wsj.com/articles/wells-fargo-ceo-defends-bank-culture-lays-blame-with-bad-employees-1473784452">Wall Street Journal interview</a> shortly after the story broke, Stumpf refused to admit any institutional failure at the bank, claiming the behavior of the terminated employees “in no way reflects our culture nor reflects the great work the other vast majority of the people do.” </p>
<p>If Stumpf thinks that over 5,000 unethical people just so happened to find their way to Wells Fargo, he may want to rethink the company’s hiring practices.</p>
<p>Thus far the company has declined to say how many branch, regional or corporate managers were among those let go. The initial readout seems to be that most of those dismissed were low-level branch employees – hardly your typical Wall Street villains.</p>
<p>The spotlight has now turned to senior managers, and what they did or did not know. It is shining brightest on Carrie Tolstedt, who has run Wells Fargo’s community banking division since 2008 and is set to retire at the end of the year. <a href="http://money.cnn.com/2016/09/12/investing/wells-fargo-fake-accounts-exec-payday/index.html">Tolstedt appears to have profited handsomely</a> from the sales practices in question. </p>
<p>A <a href="https://www08.wellsfargomedia.com/assets/pdf/about/investor-relations/annual-reports/2015-proxy-statement.pdf">2015 company filing</a> indicates that part of Tolstedt’s 2014 inventive compensation award of roughly $8 million stems from:</p>
<blockquote>
<p>“success in furthering the company’s objectives of cross-selling products from other business lines to customers, reinforcing a strong risk culture and continuing to strengthen risk management practices in our businesses.” </p>
</blockquote>
<p>It now appears that cross-selling products and strengthening risk management were competing objectives.</p>
<h2>Clawing back compensation</h2>
<p>As noted earlier, Wells Fargo says it’s already in compliance with the main provisions of the proposed rule.</p>
<p>Specifically, in a <a href="https://www08.wellsfargomedia.com/assets/pdf/about/investor-relations/annual-reports/2016-proxy-statement.pdf">recent filing</a>, the bank claims: </p>
<blockquote>
<p>“Wells Fargo has strong recoupment and clawback policies in place designed so that incentive compensation awards to our named executives encourage the creation of long-term, sustainable performance, while at the same time discourage our executives from taking imprudent or excessive risks that would adversely impact the Company.” </p>
</blockquote>
<p>This means the bank can cancel, or claw back, any incentive-based executive compensation, such as deferred bonuses or stock options, from executives who engaged in misconduct or who received such compensation based upon materially inaccurate information, “whether or not the executive was responsible.” </p>
<p>Thus far the company has given no indication it intends to claw back any of Tolstedt’s compensation, although <a href="http://www.wsj.com/articles/lawmakers-intensify-pressure-on-wells-fargo-1474048652?tesla=y">pressure</a> from the public and regulators may soon change this. </p>
<h2>The proposed rule</h2>
<p>So let’s imagine the new incentive-based compensation rule was already in place and consider how it would work. </p>
<p>The rule’s most stringent requirements apply to “level 1” financial institutions like Wells Fargo with over $250 billion in consolidated assets. Its provisions cover all employees who receive incentive-based compensation, with enhanced requirements for individuals referred to as senior executive officers and significant risk takers.</p>
<p>As head of a major business line, Tolstedt would qualify as a senior executive officer, and her compensation would be subject to:</p>
<ul>
<li><p>higher minimum deferral requirements – the percentage of incentive-based compensation that cannot be cashed in until the passing of a specific amount of time (meant to encourage long-term thinking);</p></li>
<li><p>forfeiture of “unvested” compensation (that is, compensation that has been awarded but has yet to be fully transferred to the employee); and</p></li>
<li><p>clawbacks for so-called vested compensation that has already been transferred to the employee.</p></li>
</ul>
<p>Since Tolstedt is retiring soon, the rule’s minimum deferral requirements are less relevant here. But for past performance periods, unvested compensation could be forfeited and vested pay could be clawed back.</p>
<p>Even if one generously assumes Tolstedt was unaware of the fraud taking place, she was still likely responsible for setting the sales goals and compensation structure that incentivized so many employees to defraud customers. Indeed the firm’s own <a href="https://www08.wellsfargomedia.com/assets/pdf/about/investor-relations/annual-reports/2014-proxy-statement.pdf">filings</a> with the SEC seem to confirm this. Using these assumptions and applying the text of the proposed rule, it is clear that nearly all of her unvested incentive-based compensation could be forfeited, and her vested compensation could also be at risk of being clawed back. </p>
<p>The proposed rule identifies several types of events that would require covered firms to initiate a forfeiture review. Those most relevant in the Wells Fargo situation include: </p>
<ul>
<li><p>inappropriate risk-taking, regardless of the impact on financial performance; </p></li>
<li><p>material failures of risk management or control; or</p></li>
<li><p>noncompliance with statutory, regulatory or supervisory standards that results in enforcement or legal action against the covered institution brought by a federal or state regulator or agency. </p></li>
</ul>
<p>The proposal leaves it to the firm to determine the amount to be forfeited, provided it can support its decisions.</p>
<p>The standards that trigger a review of whether vested compensation should be clawed back are higher (though firms can loosen them). Such situations include a senior executive officer engaging in misconduct that results in significant financial or reputational harm to the institution, fraud or intentional misrepresentation of information used to determine the employee’s incentive-based compensation. </p>
<p>Based on the facts as we currently know them, it would be difficult to prove Tolstedt met the rule’s clawback criteria, since it’s not known if she actually engaged in the fraud herself. If she had, all of the incentive-based compensation that had vested since the fraudulent activity began would be subject to being clawed back. </p>
<h2>‘Standard-bearer of our culture’</h2>
<p>Assuming the rule was currently in effect, and Wells Fargo was adhering to it, how much would Tolstedt stand to lose? </p>
<p>This is almost impossible to determine given that she has worked at the firm for 27 years, we don’t know how long the fraudulent activity went on for, publicly available information on her compensation is limited and the rule leaves it up to the firm to determine the dollar amount that is forfeited and/or clawed back. </p>
<p>The Consumer Financial Protection Bureau’s <a href="http://files.consumerfinance.gov/f/documents/092016_cfpb_WFBconsentorder.pdf">Wells Fargo ruling</a> indicates the “relevant period” lasted from Jan. 1, 2011, to Sept. 8, 2016. Over that time frame, Tolstedt received at least $36 million in incentive-based compensation, compared with $8.5 million in base salary. </p>
<p>Under the terms of the proposed rule, Wells Fargo would be able to get back at least half of the $36 million. If Tolstedt was found to have known about the fraud taking place within her division, they could likely get it all back. </p>
<p>When the firm announced in July that Tolstedt would be retiring at the end of the year, <a href="http://fortune.com/2016/09/12/wells-fargo-cfpb-carrie-tolstedt/">Stumpf referred to her</a> as a “standard-bearer of our culture” and “a champion for our customers.” At the time, the firm was winding down its five-year employee purge. </p>
<p>Knowing what we know now, Stumpf could have easily fired her and attempted to claw back a significant amount of her pay. Instead he chose loyalty to a long-time employee over loyalty to his customers. Next time that choice may be off the table.</p><img src="https://counter.theconversation.com/content/65631/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Lee Reiners spent five years working at the Federal Reserve Bank of New York. During that time, he supervised several large financial institutions. He did not supervise Wells Fargo.</span></em></p>Regulators fined Wells Fargo US$185 million for fraudulently opening up more than two million fake deposit and credit card accounts. Will the victims get their pound of flesh from those responsible?Lee Reiners, Director of Global Financial Markets Center, Duke UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/607582016-07-29T09:32:32Z2016-07-29T09:32:32ZCan your Facebook friends influence your decision to buy a house?<p>People interact with their family, friends and coworkers on a daily basis, both through online social networks and in real life. The effects of such social interactions on economic and financial decision making, however, are not well-understood. </p>
<p>Do such interactions influence people’s assessment of the attractiveness of investments such as houses or stocks, and is this reflected in actual investment behavior? And can social interactions influence market-level trading volume and asset prices? </p>
<p><a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2753881">Recent research</a> we conducted on the housing market makes progress toward better understanding the importance of social interactions in shaping economic and financial decision-making. In particular, we analyzed whether people are more likely to consider housing a good investment if their friends experienced recent house price increases and whether this affected their actual real estate investments.</p>
<h2>Measuring friends’ house price experiences</h2>
<p>We started our research by constructing a measure of the house price experiences of different people’s friends. In other words, we wanted to capture how house prices changed in those locations where an individual has friends. </p>
<p>To do this, we analyzed an anonymized snapshot of Facebook’s social graph, which consists of all friendship links between Facebook users in the U.S., combined with the county-level location of each user. </p>
<p>For example, we <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2753881">created a heat map</a> that shows the overall number of friendship links of all residents of Los Angeles County with residents in all other counties in the continental U.S., where darker shades mean more connections. As you would expect, there are some parts of the country with relatively more friendship connections to L.A., and others with fewer such connections. L.A. residents have the most friends around L.A. itself, but also elsewhere on the West Coast, in the New York area and in Florida.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/132054/original/image-20160726-7033-fai8my.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/132054/original/image-20160726-7033-fai8my.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=346&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/132054/original/image-20160726-7033-fai8my.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=346&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/132054/original/image-20160726-7033-fai8my.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=346&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/132054/original/image-20160726-7033-fai8my.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=435&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/132054/original/image-20160726-7033-fai8my.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=435&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/132054/original/image-20160726-7033-fai8my.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=435&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">This map shows where L.A. County residents have the most friends.</span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>One thing worth mentioning is that while we measure the location of individuals’ friends through Facebook, we believe that this is informative of where these individuals’ broader social networks are located. This broader social network includes their friends that might not be Facebook users, and whom they would interact with offline.</p>
<p>We combined this information on where individuals’ friends live with data on how house prices evolved in the last years in these locations. For each individual in L.A., we then calculated the average house price experience of all of her friends – or, in other words, the house price experiences in her social network. Since house price movements are not the same across the U.S., individuals with friends in different parts of the country see very different house price experiences in their social networks. </p>
<p>As an illustration, we <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2753881">showed</a> the distribution of the house price experiences in the social networks of all L.A. residents between December 2008 and December 2010. You can see that some individuals living in L.A. had friends that experienced an average house price decline of 12 percent over this period, while others had friends who experienced an average house price decline of about four percent.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/132055/original/image-20160726-7045-1tzjalg.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/132055/original/image-20160726-7045-1tzjalg.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=432&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/132055/original/image-20160726-7045-1tzjalg.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=432&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/132055/original/image-20160726-7045-1tzjalg.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=432&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/132055/original/image-20160726-7045-1tzjalg.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=543&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/132055/original/image-20160726-7045-1tzjalg.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=543&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/132055/original/image-20160726-7045-1tzjalg.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=543&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">This figure shows the ‘house-price experiences’ of residents of L.A. County.</span>
<span class="attribution"><span class="license">Author provided</span></span>
</figcaption>
</figure>
<h2>Impact on housing market perceptions</h2>
<p>After getting a sense of the different house price changes that people experienced through their friendship networks, we wanted to investigate whether social interactions with these friends actually affected their decisions to invest in real estate. We looked at this in two ways: by considering how attractive they considered investing in local real estate to be and by analyzing their actual home purchase behavior. </p>
<p>To evaluate the effects on housing market beliefs, we analyzed responses to a housing market survey conducted among Los Angeles-based Facebook users. The survey asked users how often they discussed property investments with their friends and how attractive they thought investments in their own local housing market were. We discovered a strong relationship between the housing market experiences within a respondent’s social network and the extent to which that respondent considered local real estate to be a good investment. </p>
<p>That is, if a respondent’s friends lived in counties that experienced sharp price drops, then he or she would be less likely to perceive their local housing market as attractive, and vice versa. We also found that the beliefs of those respondents who reported talking regularly about housing investments with their friends were more influenced by their friends’ house price experiences. </p>
<p>These findings suggest that people’s perception of the attractiveness of their local housing markets actually changed as a result of the house price experiences of their friends.</p>
<h2>Impact on housing investment decisions</h2>
<p>We also wanted to see if we would find an impact of the house price experiences of people’s friends on their actual housing market activity. For example, does experiencing rising prices through one’s friends make someone more likely to buy a home?</p>
<p>To analyze this question, we examined public record deeds data of Los Angeles-based Facebook users. We focused on three aspects of housing market behavior: the likelihood of a renter becoming a homeowner, the size of the purchased house and the price paid for the home. </p>
<p>We found that renters whose friends experienced a significant increase in housing prices were more likely to buy a home over the subsequent two years. Specifically, we found that, on average, about 18 percent of renters in our sample became homeowners during that period of time. However, for ever five percentage point higher house price experience of their friends, renters were 3.1 percentage points more likely to buy a home. </p>
<p>Our research also showed that those individuals bought homes that were, on average. 1.7 percent larger, and were willing to pay 3.3 percent more for a given property. Conversely, homeowners whose friends experienced housing price decreases were more likely to sell their properties and become renters. </p>
<p>Overall, these findings on the investment behavior of individuals are highly consistent with our conclusions from the expectation survey: People that experience substantial house-price growth in their social network become more optimistic about their local housing market and actually end up investing more in real estate.</p>
<p>We also analyzed whether the dispersion in house-price experiences within a person’s social network affects that person’s housing investment behavior. That is, we considered whether people behave differently when they are exposed to friends with very different house price experiences relative to people whose friends all had similar experiences.</p>
<p>We find that given the same average experience of a person’s friends, having more extreme positive and negative experiences (i.e., a higher dispersion) within one’s social network leads to less investment in housing. We think that this is likely the case because experiencing more extreme housing market outcomes through one’s friends signals that housing is a more risky investment.</p>
<h2>What’s the broader impact</h2>
<p>These effects of friends’ house-price experiences on individual-level housing investments are statistically significant and quantitatively large. But can they fundamentally affect what happens across an entire housing market? </p>
<p>To answer this question, we considered the extent to which these individual decisions aggregate up to influence county-level real estate trading volumes and house prices. We carried out this analysis by examining data from 831 U.S. counties between 1998 and 2012.</p>
<p>For the nitty-gritty of how we did this analysis, <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2753881">you can read our report</a>. But to summarize our results, our estimates suggest that higher house-price experiences of the friends of people living in a county do in fact lead to an increase in county-level housing prices.</p>
<p>This suggests that social interactions can <a href="http://www.kellogg.northwestern.edu/faculty/defusco/documents/DeFuscoDingFerreiraGyourko2016.pdf">propagate house-price shocks</a> across the United States. </p>
<p>For example, consider the recent tech boom <a href="http://wolfstreet.com/2016/05/18/silicon-valley-housing-market-hit-by-china-tech-ipo-swoon-stock-market/">driving up house prices in Silicon Valley</a>. Our findings imply that individuals in other counties with friends in Silicon Valley are likely to become more optimistic about their own local housing market, even though there might be no fundamental reason for this. In this way, fundamental house price increases in some parts of the U.S. can cause price movements that look like housing bubbles in other parts of the United States.</p>
<p>So what can we make of all this? To us, these findings highlight that social interactions do indeed have a large impact on individuals’ housing market beliefs and housing investment behavior. More broadly, we expect that social interactions also play an important role in other domains of economic and financial decision-making, and we hope that future research can shed further light on this.</p><img src="https://counter.theconversation.com/content/60758/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The research described in this article was facilitated through a research consulting agreement between the academic authors and Facebook. This cooperation was established to allow researchers to collaborate with Facebook in order to exploit small, anonymized data sets based on Facebook’s unique data asset to address questions of policy importance.</span></em></p><p class="fine-print"><em><span>.Johannes Stroebel&#39;s disclosure is the same as above. </span></em></p><p class="fine-print"><em><span>Ruiqing Cao&#39;s disclosure is the same as above. </span></em></p>Research suggests how your online friends experienced the housing collapse affected how you perceived your local real estate market.Theresa Kuchler, Assistant Professor of Finance, New York UniversityJohannes Stroebel, Assistant Professor of Finance, New York UniversityRuiqing Cao, Ph.D. Candidate in Economics, Harvard UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/610472016-07-20T09:52:21Z2016-07-20T09:52:21ZHow poverty has radically shifted across Europe in the last decade<p>Brexit caps off a turbulent decade for the EU. Many in the eurozone will be hoping that it does not cause further economic turmoil, as it is becoming increasingly clear that the financial crisis of 2008-09 led to a substantial increase in poverty across the continent. </p>
<p>Not only did poverty intensify within those nations that were hardest hit during the crisis and required bailouts, but there has also been a dramatic change in the geography and types of poverty in Europe over the last decade.</p>
<p>So intense has been the crisis in Greece that, by 2013, it experienced a higher level of poverty than any other EU member state. Indeed, in my <a href="http://www.ejss.eu/pdf_file/ITS/EJSS_18_01_0002.pdf">recent research</a>, I’ve found that the impoverishment of Greece, Italy, Cyprus, Spain and Portugal has been so severe that these southern European countries, taken together, had higher levels of poverty and deprivation than many of the former Communist nations that joined the European Union in 2004. Specifically, they have been greater than the average of Slovenia, Slovakia, Czech Republic, Poland and Hungary.</p>
<p>Poverty takes many different forms. The EU aims to lift 20m people out of poverty and social exclusion, based on three official measures: relative income poverty (when a person’s income falls far below what is needed to achieve an average standard of living in their country); material deprivation (when people lack a set of basic necessities); and living in a workless household. </p>
<p>To take into account the complexity of poverty, I included four more measures in my research: when people reported that they could make ends meet only with great difficulty; when they experienced neighbourhood problems such as crime or vandalism; poor health; and unmet medical or dental needs.</p>
<p>Bringing together these seven dimensions of poverty, I analysed how they changed over four time periods: 2005, 2008, 2011 and 2013. So, before, during and after the financial crisis, and the ensuing recession.</p>
<h2>Surprising findings</h2>
<p>Significant changes in the geography of poverty and deprivation in Europe can be seen. The pre-crisis period between 2005 and 2008 was associated with substantial reductions in poverty across Europe. Some of the poorest nations, including Poland and Latvia, saw the largest decrease. These pre-crisis years represented a period of catch-up for some of the poorest member states.</p>
<p>In the initial phase of the Great Recession that followed the financial crisis (2008-11), poverty increased almost everywhere. The largest increases were in Greece, Latvia, Lithuania and Ireland. But in the second phase of the crisis (2011-13), the picture is less consistent. In ten EU member states there were modest reductions in poverty, suggesting perhaps that the crisis had come to an end. In Greece, Portugal, Spain, however, poverty continued to rise sharply and similarly, though not quite as much, in Cyprus.</p>
<p>Many of the nations with the sharpest rises in poverty during the Great Recession – Greece, Cyprus, Portugal and Ireland – are nations that required bailouts from the EU and IMF. The fact that these “bailout nations” were at the sharp end of the crisis may come as no surprise, given the austerity that was demanded of them as a condition of accessing loans from the EU-IMF.</p>
<p>But two findings are nonetheless striking: </p>
<ol>
<li><p>The disappointing performance of the southern European nations predates the crisis itself. These nations largely failed to benefit from the reductions in poverty and deprivation that were experienced elsewhere in the pre-crisis years. </p></li>
<li><p>The rise in poverty in Greece has been so great that it has leapfrogged the newer EU member states and now heads the leader-board of poverty and deprivation. </p></li>
</ol>
<p>The graph below gives an illustration of how multidimensional poverty levels have changed from 2005 to 2013 for each EU member state (Greece is EL). The poverty levels are based on the simultaneous experience of three or more of the seven dimensions discussed earlier.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/130449/original/image-20160713-12353-1syp13m.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img alt="" src="https://images.theconversation.com/files/130449/original/image-20160713-12353-1syp13m.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/130449/original/image-20160713-12353-1syp13m.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=407&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/130449/original/image-20160713-12353-1syp13m.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=407&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/130449/original/image-20160713-12353-1syp13m.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=407&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/130449/original/image-20160713-12353-1syp13m.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=511&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/130449/original/image-20160713-12353-1syp13m.jpg?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=511&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/130449/original/image-20160713-12353-1syp13m.jpg?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=511&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
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<span class="attribution"><span class="source">Rod Hick</span></span>
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</figure>
<p>There have also been changes in which EU member state has the greatest number of people experiencing these multiple forms of poverty.</p>
<p>A decade ago, Poland had a greater number of people experiencing multidimensional poverty than any other EU member state. This reflected the lower standard of living in the member states that joined the EU as part of its 2004 enlargement, and the large population size of Poland. </p>
<p>By 2013, however, the combined effect of a partial catch up by the newer member states and disastrous poverty performance of southern Europe meant that Italy now has a greater number of people experiencing multidimensional poverty than any other country in Europe.</p>
<p>The rise in poverty at Europe’s periphery thus reflects not only a deterioration of pre-crisis standards of living within some nations. It shows the more radical shift in the geography of poverty in Europe over the last decade, increasingly concentrated in the south of the continent. This is something the European Union must pay heed to, as it aims to help lift 20m people out of poverty across the continent.</p><img src="https://counter.theconversation.com/content/61047/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rod Hick does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>New research shows how the financial crisis led to a dramatic shift in poverty across Europe.Rod Hick, Lecturer in Social Policy, Cardiff UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/623292016-07-12T15:45:49Z2016-07-12T15:45:49ZHow Brexit opened up the Pandora’s box of Italy's banking malaise<p>Brexit has triggered a financial chain reaction that has also exposed the problems of the Italian banking system. The UK’s decision to leave the EU made investors fearful that the union would face a new crisis or even break up. This led to a swift withdrawal of their funds from the most fragile sections of Europe’s financial markets.</p>
<p>Italian banks are one of these areas. The graph below shows the steep fall of Italy’s FTSE Italia All-Share banks index following the UK’s referendum result.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/130078/original/image-20160711-9292-19fbbaf.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/130078/original/image-20160711-9292-19fbbaf.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=318&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/130078/original/image-20160711-9292-19fbbaf.png?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=318&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/130078/original/image-20160711-9292-19fbbaf.png?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=318&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/130078/original/image-20160711-9292-19fbbaf.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=399&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/130078/original/image-20160711-9292-19fbbaf.png?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=399&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/130078/original/image-20160711-9292-19fbbaf.png?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=399&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
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</figure>
<p>The main problem with Italy’s banks is that they are swamped with what are known as non-performing loans (NPLs). These are loans on which debtors have not made scheduled payments for at least 90 days.</p>
<p>In other words, Italian banks are not getting back some of the money they have lent out. According to data from the <a href="https://www.bancaditalia.it/pubblicazioni/rapporto-stabilita/2016-1/en-FSR-1-2016.pdf?language_id=1">Bank of Italy</a>, NPLs of Italian banks amounted to €360 billion in 2015, or 18.1% of all loans they made (see graph below). Of these loans, €210 billion are really bad and no longer collectable. The remaining €150 billion are of slightly higher quality. </p>
<p>Italian banks are incredibly exposed to NPLs. They equal almost a quarter of Italy’s GDP and a third of the total <a href="http://www.wsj.com/articles/imf-urges-urgent-action-on-europes-bad-loans-1443103382">NPL exposure of EU members</a>. Practically speaking, NPLs are a big drag on the ability of Italian banks to finance <a href="http://www.oecd.org/eco/surveys/Overview_Italy_2015_ENG.pdf">investments and growth</a> in the real economy. Accordingly, it is <a href="https://www.theguardian.com/world/2016/may/10/battle-prop-up-italy-banks-eu-brexit-grexit-bad-loans">a major threat</a> to the stability of the entire EU.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/130079/original/image-20160711-9295-10yle2u.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" srcset="https://images.theconversation.com/files/130079/original/image-20160711-9295-10yle2u.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=600&amp;h=364&amp;fit=crop&amp;dpr=1 600w, https://images.theconversation.com/files/130079/original/image-20160711-9295-10yle2u.png?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=600&amp;h=364&amp;fit=crop&amp;dpr=2 1200w, https://images.theconversation.com/files/130079/original/image-20160711-9295-10yle2u.png?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=600&amp;h=364&amp;fit=crop&amp;dpr=3 1800w, https://images.theconversation.com/files/130079/original/image-20160711-9295-10yle2u.png?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;h=457&amp;fit=crop&amp;dpr=1 754w, https://images.theconversation.com/files/130079/original/image-20160711-9295-10yle2u.png?ixlib=rb-1.1.0&amp;q=30&amp;auto=format&amp;w=754&amp;h=457&amp;fit=crop&amp;dpr=2 1508w, https://images.theconversation.com/files/130079/original/image-20160711-9295-10yle2u.png?ixlib=rb-1.1.0&amp;q=15&amp;auto=format&amp;w=754&amp;h=457&amp;fit=crop&amp;dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<p>The NPL problem has its origins in the seven-year <a href="https://www.bancaditalia.it/pubblicazioni/rapporto-stabilita/2016-1/en-FSR-1-2016.pdf?language_id=1">recession</a> that followed the 2008 global financial crisis and the ensuing European sovereign debt crisis. The reason is simple: if the economy does not go well, companies and households struggle to repay their debt to the banks. </p>
<p>However, another cause of the NPL problem is the fact that Italian bank managers also made bad investment decisions, often allocating loans on the basis of <a href="http://www.ilfattoquotidiano.it/2013/10/28/sofferenze-bancarie-sono-causate-dai-prestiti-facili-ad-amici-e-furbetti/757379/">favouritism</a>. Hence, it would not be an exaggeration to say that an <a href="http://www.ilsole24ore.com/art/commenti-e-idee/2016-07-02/salvare-banche-far-ripartire-l-economia-195902.shtml?uuid=AD6txCn">independent inquiry</a> on the issue should be established, a sort of NPL audit which should be open to independent experts and civil society.</p>
<h2>Government incapacity</h2>
<p>Another cause of the NPL crisis is the Italian government’s inability to solve the issue, <a href="http://bruegel.org/2016/02/hard-times-for-italian-banks/">as other European countries have</a>. Germany and France for example intervened directly with state funds to provide new capital to their banks, thanks also to relatively more solid public finances. </p>
<p>Ireland and Spain have instead used <a href="http://www.mckinsey.com/industries/financial-services/our-insights/understanding-the-bad-bank">bad banks</a> co-funded by both state and private investors. These so-called bad banks use these funds to buy other financial institutions’ bad loans. They focus on managing the non-performing assets, for instance by trying to recover the money from borrowers. The other institutions, relieved of their bad debts, can instead healthily resume their normal activities of lending and borrowing. Direct state bail-out and bad banks are not mutually exclusive solutions. In fact, they are often used together. </p>
<p>In the case of Italy, the government could not intervene directly with public money. Italy’s huge <a href="http://www.tandfonline.com/doi/abs/10.1080/13563467.2015.1079168?journalCode=cnpe20">public debt</a> does not give fiscal space for substantial public funds going to struggling banks. Some exceptions were made for several banks including <a href="http://www.bloomberg.com/news/articles/2013-10-24/monte-paschi-born-out-of-black-death-struggles-to-survive">Banca Monte dei Paschi di Siena</a> in the period 2008-12.</p>
<p>More importantly, by the time the Italian government decided it would do something about <a href="https://next.ft.com/content/33c4c632-9100-11e5-bd82-c1fb87bef7af">four small troubled banks</a> in 2015, new <a href="https://www.pwc.com/im/en/publications/assets/pwc_eu_bank_recovery_and_resolution_directive_triumph_or_tragedy.pdf">EU rules</a>, including a <a href="http://lexicon.ft.com/Term?term=bail_in">bail-in</a>, were already on their way to being fully implemented. These dictate that when a bank is in crisis, its creditors – bondholders and depositors together with shareholders – would bear the burden by having part of the debt they are owed written off. This was so that governments could avoid rescuing banks using taxpayer money.</p>
<p>To cut a long story short: Italy’s banks are in a dire enough situation to require direct state intervention, but this cannot be done under current EU banking regulation. As a result, the Italian government is negotiating with the European Commission to develop alternative and more <a href="http://bruegel.org/2016/02/hard-times-for-italian-banks/">complex solutions</a> which avoid relying on taxpayer money. Unfortunately, these would merely keep the banks alive, but do not thoroughly restructure their governance and business strategies so that they could start <a href="http://www.ilsole24ore.com/art/commenti-e-idee/2016-07-02/salvare-banche-far-ripartire-l-economia-195902.shtml?uuid=AD6txCn">lending again</a>.</p>
<p>At this point, the most <a href="http://www.italy24.ilsole24ore.com/art/business-and-economy/2016-06-28/analisi-131922.php?uuid=ADp6iZk">appropriate solution</a> would be to inject public capital into the banking system under strict conditions which impose a more effective governance and business strategy on the bailed-out banks. The <a href="http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html">Swedish case</a> in 1992 shows that banks can be held responsible and the government can become an owner. What is more, the Swedish government was also able to make a profit once it sold the shares of the banks later on.</p>
<p>Direct state intervention would prevent <a href="https://next.ft.com/content/54cda5e4-a6ac-11e5-955c-1e1d6de94879">small investors</a> from having their savings wiped out. These retail investors hold <a href="http://bruegel.org/2016/02/hard-times-for-italian-banks/">a third</a> of all bonds issued by Italian banks, but are not always fully aware <a href="http://www.corriere.it/politica/16_maggio_11/banca-etruria-indagine-si-consob-c22ebd2e-16e8-11e6-a3a2-ca09c5452a5d.shtml">of the risks</a> their bank managers exposed them to. More generally, direct state intervention would help kickstart <a href="https://next.ft.com/content/621298c2-c2d2-3c14-976b-1e30e2d10815">economic growth</a> in a country that so desperately needs it.</p><img src="https://counter.theconversation.com/content/62329/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andrea Lagna does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The Italian banking system is on the verge of a crisis. Direct state intervention is needed to solve the problem.Andrea Lagna, Lecturer in International Business, Strategy and Innovation, Loughborough UniversityLicensed as Creative Commons – attribution, no derivatives.